All week long, low-fee, 30-year mortgage rates floated just above 5.5 percent, and early this morning looked as though they might break through, going down. Ain’t gonna happen, not right now: at midday, the bond market reversed, the 10-year T-note flinching at 3.93 percent – its October ’03 low – and rising to 4.07 percent.
Day to day, shade-tree economists at bond market screens get good information by watching the instantaneous response to brand-new news. The on-screen verdict without mercy reinforces or demolishes theories in play.
Some of the most informative weeks are the ones like this, absent any of the usual market-moving economic data – jobs, inflation, economic growth – but a significant move anyway. This week’s trading solves a puzzle of the last month, and more: why would bonds rally – prices up, rates down – without help from bad news about the economy?
The answer: the financial politics of trade and currencies. Japan has recently bought immense quantities of dollars, in effect recycling its entire net-export winnings in order to prevent the yen from rising in value from 105/buck to 100. Japan’s exporters believe that such a rise would be a catastrophe for them. In Europe, a similar disaster may already be under way at a $1.30 euro, and its central bankers may be forced to cut its 2.25 percent overnight rate in order to reduce the dollar flow to the euro. Interest-rate differentials are the biggest currency driver of them all, and with our Fed at 1 percent, a 2.25 percent-paying euro has been very attractive.
Money flowing to the dollar, for whatever cockamamie reason, inevitably causes bonds to rise in value because they are the instruments that foreign central banks buy in order to buy dollars.
China’s currency floats with the dollar, and to maintain the float it must reinvest into dollars most of its $100-billion net annual export earnings. China and Japan now own about a quarter of the marketable U.S. Treasurys outstanding, and are buying like mad…and people wonder why rates are falling despite our deficit!
It all works as long as it works. The unsustainable component in the world economy may be the American trade deficit, but there are two other fragile spots in this Rube Goldberg scheme: China’s growth may be spinning out of control, bubbling, and the whole of global economic growth depends on sustaining the American growth rate.
China’s economy has grown at an average 9 percent rate during each of the last 10 years. Compounding at vast rates is possible during the initial stages of development, when GDP is small; however, China’s GDP has crossed the $1.5-trillion mark, and future 9 percent growth is about to produce one of those bubble hyperbolas.
As for the American driver: Stephen Roach of Morgan Stanley says that 96 percent of the cumulative 1995-2002 increase in global GDP was accounted for by the United States. Goody for us, but our growth is based on a borrowing rate that must slow.
There are several ways by which the world economy may adjust itself to a sustainable track. The most probable: super-easy money here may produce the much-ballyhooed, nowhere in sight “synchronized global recovery.” Pressure on the euro may finally force Europe to break the ossification of its economy, and complacency with 1 percent annual growth, while the Asian exporters’ dollar-peg links their internal economies to our Fed’s extreme stimulus, and their rapid growth may begin to take the load off the one U.S. horse pulling the global shay.
While this adjustment is underway, the world economy is just as accident-prone as it was in 1997-8. Bonds failed to break the technical 3.93 percent barrier this week, but one little teensy, panic-inducing accident, and we will.
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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