Why fear of Fed action isn’t sending mortgage rates skyward

Rates are vulnerable to the Fed, but held down by Europe's troubles

In a world and life filled with uncertainty, it is gratifying to watch markets behave exactly as they should.

Bonds and mortgages got a bad scare on Wednesday, rates up sharply, but as the full picture revealed itself rates are back where we started. A lot else is not where it began this week, nor will it be soon.

Militia members being sworn into service on June 21 in the separatist stronghold of Donetsk, Ukraine. Denis Kornilov / Shutterstock.com
Militia members being sworn into service on June 21 in the separatist stronghold of Donetsk, Ukraine. Denis Kornilov / Shutterstock.com

The catalyst for Wednesday, like an overdone pool-table break: Second-quarter GDP arrived at a 4 percent growth rate. Everyone expected a rebound from the negative first quarter, but not an upward revision in that negative (from minus 2.9 percent to minus 2.1 percent), and especially not indications of rising spending, incomes and inflation. Real personal consumption expenditures jumped 2.5 percent in Q2 versus 1.2 percent in Q1, and the PCE “deflator” (converting nominal to after-inflation) popped to 1.9 percent from 1.4 percent.

The immediate reaction: Here comes the Fed. Bonds and mortgages instantly flipped to bearish trend.

But the world is a big, complicated and interconnected place. On Wednesday Europe at last dropped meaningful sanctions on Czar Vladimir, certain to slow the world to some degree from wherever it was going.

On Wednesday the stock market sat and watched the show. Thursday morning another Fed scare: The employment cost index (ECI) in Q2 jumped 0.7 percent from 0.3 percent in Q1. Then, beginning in Europe, stocks free-fell; at this writing the Russell 2000 has lost 4.14 percent of its value in 48 hours.

Friday morning … the gorilla, job data for July. Payroll gains were slimmer than forecast, no acceleration anywhere in the report, and soggiest of all: Hourly earnings rose from $24.44 to $24.45. One measly cent, statistically unchanged. The pattern continues: Most of those taking jobs seem to be throwing in the towel, accepting inferior pay. Revisiting data from the day before: The rise in ECI came from benefits, not wages, likely transient or another accounting quirk of “Obamacare.”

The pattern continues: Most of those taking jobs seem to be throwing in the towel, accepting inferior pay."

Tie all of this together: The stock market is very vulnerable to the Fed, whenever it does move. The data do not support the Fed moving any earlier than sometime mid-to-late 2015, and the Fed will need to see a lot of growth and income gains before then.

Mortgages and bonds are vulnerable, too, but long-term rates are held down by Europe’s troubles. The German 10-year bund fell to 1.14 percent. Those looking for safety find more yield in our bonds. Newly disturbing signs in Europe: Club Med bond yields have been falling with the bund, but rose today. Lousy economic data and the collapse of Portugal’s Banco Espirito Santo have Italian and Spanish yields rising. That’s credit fear, default fear. The eurozone ever closer to the deflation precipice, inflation 0.4 percent.

Then the fun part: Dismissing tin-hat people and theories. The Philly Fed’s Plosser dissented from the Fed’s on-course meeting minutes. Too easy, he has always thought. In his pinched mind the Fed should never do anything. Richard Fisher, prez of the Dallas Fed twice this week insisted that the Fed should accelerate rate hikes. This wavy-haired graduate of the Boehner Tanning Salon is a classic Texas yahoo, a grandstander without the conviction to cast his own dissent.

The stock market’s two-day crater is a “beneficial correction.” Uh-huh. Although it’s true that the market has just coughed up this summer’s unreasonable gains, its prior gains are not necessarily sustainable.

Who knew? Despite Arabia’s general hatred of Israel, many hate and fear Hamas more. Thus a flash point does not flash.

Who has it right? Bill Gross of PIMCO, still holding title as Best All-Time Bond Trader. “Structural global growth rates have come down due to a yawning gap of aggregate demand relative to aggregate supply.” If you have overinvested in supply, none of the demand-boosting tricks can work. Only time will rebalance.

As frustrating as it may feel here in the U.S., we are adapting faster than any other place.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.


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