Mortgage rates fell to their lowest level in a month, down to 6.25 percent from the 6.5 percent peak.

The largest element in the decline has been the causeless relaxation common to market retracements after hysterical intervals. Wall Street operators often use the term “correction” in order to comfort a client’s suddenly shirtless condition, but this bond-market bounce-back was legit.

The newest data on the economy show moderation from the whatwazzat explosion in March: orders for durable goods were expected to flatten in April, but fell hard, down 2.9 percent. Sales of new homes dropped 11.8 percent in April, the biggest monthly decline in 10 years, although resales gained 2.5 percent. Insider sales of stock broke the 1971 record (Vickers Weekly Insider Report), perhaps boosted by the GDP report of only 1.2 percent growth in 1st quarter ’04 total-economy business profit, way off the prior two quarters’ 7.2 percent and 9.9 percent, respectively.

Of all the economic data, the most beneficial surprise was a revision in 1st quarter inflation data. The “personal consumption expenditure deflator” (“PCE”) was originally reported as a 2 percent annualized increase from 1.2 percent in the 4th quarter ’03, but the revision knocked down the 1st quarter increase to only 1.7 percent.

How can a 0.3 percent revision be a big deal? Get used to this point-something parsing. The Fed wants the inflation rate in the 1.5 percent to 2 percent range (as measured by excellent measures like the PCE, not CPI). The Fed will react fiercely to any threat of 2.5 percent-plus inflation, and the original PCE jump from 1.2 percent to 2 percent could have been the precursor progression. However, 1.2 percent to 1.7 percent…no sweat.

The Fed is going to raise the Fed funds rate from its emergency, deflation-stopping 1 percent, but the pace and extent of the hikes to come will mean everything to the mortgage business. Our markets can adjust to a steady march of .25 percent-at-a-time to a 2.5 percent-3 percent neutral, which would imply a 5 percent-5.5 percent 10-year T-note and 6.75 percent-7.25 percent mortgages. However, if PCE spurts above 2 percent, then the holders of $5 trillion in mortgages will go back into panic mode, dumping everything at once in a desperate try to lay off risk–a rolling replay of April and the first week of May.

We and the Fed will watch, one point-something at a time…punctuated by the wildly unpredictable but powerful employment data on the first Friday of each month (next Friday…). People everywhere know that the Fed is changing regime, and rates are at risk to go higher, but the average civilian has no idea the extent of the change already behind us at these levels, nor how cautious the Fed is likely to be.

Speaking of civilians…the U of M consumer confidence measure fell from 94 to 90.2, the weakest component an 87.3-to-81.6 crash in faith in the six-month future. I assume Iraq is in play, as it is in presidential polling, in which for the first time post-Watergate a president is mired in low-40s approval despite a strong economy.

The Fed notes with pleasure that household balance sheets are in the best shape ever. I suppose so, given news of home-price appreciation in California, typical of a lot of the country, up 24 percent in the last 12 months (to a median single-family price of $453,590, not so typical). However, polling suggests poor distribution of financial health: Pew Research says that 68 percent of employed Republicans think they earn enough money to lead the life they want, but only 46 percent of Democrats feel that way. (Would they feel better if they changed parties?)

Then, there’s the civilian war front: as soon as John Ashcroft began this week’s terror warning, markets crumped–in cynical certainty that any attack here would scare us all into the flapping bejabbers, and slow the economy.

This Memorial Day, among picnics, graduations and other remembrances, take time to take a vow: promise to be tougher than the markets think we are.

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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