Mortgage rates fell a little this week, back down to 5.625 percent, assisted by some not-so-hot economic data, a non-threatening performance by Alan Greenspan, and massive buying of bonds by foreign central banks.
The data weren’t awful, but also were not consistent with a quickening economy. New claims for unemployment benefits have stabilized at 350,000 each week, retail sales grew less than 1 percent last month, and in a surprise this morning, the University of Michigan mid-month measure of consumer confidence fell hard, down 10 points to 93.1, wiping out all the gains going back to last fall.
Early this week, rates rose in fearful anticipation of Greenspan’s semiannual testimony on monetary policy to Congress. Specifically, would the Fed’s new “patient” attitude have a shorter fuse than the prior “considerable period”?
We need not have worried – the fuse isn’t lit, and Greenspan hasn’t even reached for a match. He gave us the obligatory “…the real federal funds rate will eventually need to rise toward a more neutral level,” but made plain the triumph of productivity over job growth, and gave every indication that the Fed won’t move until employment growth is sound.
Two cautions: first, all Fed speakers now emphasize that the first phase of increases in the overnight cost of money (the “fed funds” rate) will merely withdraw the Fed’s extreme ease. What a “neutral” Fed funds rate might be is a matter of continuous disagreement in the trade, but the best guess says perhaps 2.5 percent versus today’s 1 percent. The Fed obviously doesn’t want to slow the economy, but may begin at any time to reduce its stimulus.
Second caution: Greenspan suggested that the Fed could be surprised, and require more dramatic action. I suppose there is some chance that the domestic economy could tip into an inflationary episode requiring unpleasant attention, but the overwhelming risk facing the Fed and the world economy is a breakdown in our ability to borrow the money to fund our imports. In today’s news, our total trade deficit for 2003 was $489 billion.
Greenspan: “To date, the U.S. current account deficit has been financed with little difficulty.” However, everyone in the bond market is edgy about the durability of the financing mechanism. It has worked well for a long time: exporters to us earn wads of dollars, but to keep their exports cheap they must re-invest their winnings in dollar-denominated securities, principally Treasurys.
China sold $125 billion in goods to us last year, but imported only $25 billion from us; most of that $100 billion surplus has to be recycled into dollar-denominated securities, or the Chinese currency will explode in value, along with the cost of its exports, and its ability to export. Yesterday, the Treasury sold at auction $16 billion in brand-new 10-year T-notes. Foreign central banks bought 45 percent of the issue – more than double the fraction in the last auction.
It is not a good sign when half of your bidders are buying under self-imposed duress. If exporters decide that accepting payment from us in over-priced wallpaper is not worth the trouble to maintain export volume, and the whole recycling conveyor slows down, then…
The world will not end, but markets would enter (will enter, someday) a scramble for new exchange-rate and interest-rate equilibrium. We have a choice: we can let the markets raise our interest rates, which would make our wallpaper a more attractive investment, slow our economy, and cut our appetite for imports; or, before the markets seize control of our affairs, we can make our own decision to go on a borrowing diet.
Our current condition requires one of those stomach-stapling procedures.
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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