This week marked the first of several collisions ahead between markets and U.S. plans to borrow. Treasury yields have soared, but mortgages are holding in the fours.
New data failed to reinforce either the "Green Shooters" (economic optimists) or the "Agent Orangers" (economic pessimists), as prior historical guides are unreliable in a brand-new predicament.
Leading indicators rose 1 percent, the first gain in seven months. However, Orangers note that 0.44 percent of the boost came from a suspect rocket by stocks; another 0.28 percent from the jump in long-term Treasury rates, more likely to be destructive than helpful; and another roughly 0.28 percent from consumer attitudes improving from desperate to merely miserable.
The Shooters are adaptable. Tuesday’s release of new housing starts and building permits was supposed to show housing bottom, and stocks rose in anticipation. The actual numbers, down 13 percent and 3.3 percent, respectively, were the worst ever measured, but good news! Less construction must mean less supply, therefore housing bottom. Stocks rose.
The Fed’s staff produces the best forecast available. State secrets until a few years ago, these forecasts are public just three weeks after each Fed meeting. The minutes of April 28-29 (see here) were badly misread upon release this week: media and Street sources initially reported the Fed is "considering" an increase in its purchases of Treasurys, and Treasury rates fell. The same crew also reported the Fed had altered its forecast to the downside.
Wrong and wrong. There was no debate on increased purchases, merely unanimous decision to wait-to-see. Then, there are two forecasts at Fed meetings: one by the 12 regional Feds and another by the staff — the latter is historically by far the more accurate of the two.
The regional banks cut their forecast, but the staff boosted its outlook: "Real GDP to edge higher in the second half"; "Fiscal stimulus"; "Bottoming of housing"; "Turn in the inventory cycle"; "Gradual recovery of financial markets."
Markets figured it out: an improving economy and no Fed support for Treasurys? Sell. The 10-year T-note blew to 3.44 percent from the high twos of fall through winter. …CONTINUED
Mortgages are holding because the Fed is executing a $1.25 trillion buy — more than 10 percent of outstanding mortgages. This operation has successful impact because there has been no net increase in loans outstanding since 2007 (refis are a wash, and purchase of a foreclosure results in net decrease). Here we sit, mortgages roughly 4.75 percent, only 1.3 percent above the 10-year, the lowest spread in memory. If Treasurys continue to blow up, can mortgages stay put, the spread ever-narrower? I don’t know — never tried this before.
A steepening yield curve (long rates rising far above short) is supposed to forecast good times, but not when low rates and unprecedented federal borrowing are required to get out of an asset-deflation spiral. Absolutely not.
Given new-cash Treasury borrowing of at least $1.8 trillion this year, the Fed may not have the power to suppress those yields. The Obama people appear oblivious to the market damage done by their failure to address "out-year" deficits.
Treasury Secretary Timothy Geithner’s plaintive promise today to get deficit growth back to 3 percent per year just made things worse. We’re going to run our debt from 44 percent of gross domestic product to 75 percent in depression-prevention, and then grow it 3 percent per year, when we will be lucky to have GDP growing as fast? When interest rates normalize, interest on debt will wreck the budget.
The elephant in the room since Lehman September: Without blowing up rates, can we and Europe borrow as much as we must? We have borrowed and spent our way to premature prosperity for 50 years, and now must exhaust our emergency borrowing reserve.
None will remain to cushion entitlement promises to aging baby boomers. We cannot inflate our way out of debt because rates will rise and abort recovery. We may be aborting right now, rates rising and the Treasury crowding out lesser borrowers and capital raisers. Tax our way out? Uh … no.
We can grow our way out of debt trouble, but only by limiting spending. Somebody please Twitter the president before markets reach him by bullhorn.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at firstname.lastname@example.org.
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