Most of a bond-market fright has passed, and long-term rates are back to the low end of a range that has held since last July: low-fee mortgages are 5.625 percent and the 10-year T-note is 4.13 percent.

Long Treasurys had traded 4.22 percent in anticipation of all the things that could go wrong next week. On Wednesday the Fed will hike another quarter-point to 2.5 percent, but hints at its future intentions in the companion statement are the scary part.

Most of a bond-market fright has passed, and long-term rates are back to the low end of a range that has held since last July: low-fee mortgages are 5.625 percent and the 10-year T-note is 4.13 percent.

Long Treasurys had traded 4.22 percent in anticipation of all the things that could go wrong next week. On Wednesday the Fed will hike another quarter-point to 2.5 percent, but hints at its future intentions in the companion statement are the scary part. Next Friday will bring news of January payrolls, each month’s single most-powerful bond-market-moving datum, each defying all attempts at forecast. Then there’s the Iraq election, the State of the Union and congressional reaction – in sum, enough to make sensible traders get under their desks and stay there.

Offsetting all that this morning: 4th quarter ’04 GDP rose only 3.1 percent, almost a point under forecast (the United States bought foreign production, not its own). Also in the report: the best measure of inflation, the core personal consumption expenditure deflator, rose at a 1.6 percent annual rate (just about perfect); and 2004 wages gained a sorry 2.4 percent, the worst performance since Q2 ’99 and hardly an inflation threat.

The linkage between politics (foreign and domestic) and economics runs through the financial markets. Nobody has a good explanation for the lock-up in that linkage in the face of so many things that cannot remain as they are. (Exception: the consistent and predictive thinking at www.hoisingtonmgt.com.)

The Congressional Budget Office says the federal deficit will increase to $427 billion this year. John Snow, Treasury Secretary and dead-pan court jester, in a line worthy of Henny Youngman: “We are not under-taxed.” Horsefeathers: tax receipts are the lowest since WWII. The bond market did not even flicker at the deficit increase; maybe saw it coming, but it is coming.

Every representative to the global economic conference in Davos this week tried in some desperation to get us to pay attention to our trade deficit, and failed. The bond market was unmoved by the proceedings.

Every sign in Congress says that Social Security privatization and reform are DOA. Privatization would lead to unequal benefits among citizens least able to care for themselves, and all roads to reform require benefit cuts, a disaster for Republicans if attempted solo. Medicare is in vastly worse trouble than Social Security, but no one has even an unworkable plan to propose. (Mr. Snow?)

The second domestic-policy pillar, tax reform, has a fatal flaw: no money. Making the first-term cuts permanent has a shot, but that would enshrine the current deficit, leaving a $100-billion Alternative Minimum Tax bomb ticking. It should be embarrassing for the president’s SOU agenda to fail before the speech, but consumer confidence has been rising ever since the election in direct proportion to falling presidential job approval. Go figure. Markets appear neither confident nor shaken.

Everybody gets lucky, and the death of Arafat may unlock a settlement in Palestine. A courageous turnout in Iraq this weekend would be a beacon to the world and give substance to the president’s inaugural paean to freedom. However, the Pentagon says not to expect troop withdrawals before 2007, although Gen. Casey says the current force can’t be sustained. “Training Iraqis” is the great hope, but it rests on finding and empowering skilled sergeants, lieutenants and captains, and no modern Arab army has done so. The rule: colonels, generals, and a mob.

The economy is OK, the Fed is likely to stay cautious, government policy is frozen, and so is the linkage to markets. The world is moving on, and unsustainable pressures are building.

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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