The fine print. Always, always, always…wait for the fine print.

In the most-telegraphed punch in the history of the Fed, it did indeed hike the overnight cost of money from 1 percent to 1.25 percent on Wednesday. However, nothing else in the markets, in the structure of interest rates, in the perception of the economy, in the expectations for future interest rates…not one other thing went according to plan.

The net consequence of a series of surprises is a defiant bond market and 6 percent low-fee mortgages, down a half-percent from the three-month high, and down a quarter-percent since the Fed’s meeting began on Tuesday.

Going into the Fed’s first tightening move in four years, the weight of opinion in the bond market held that the Fed was behind the curve, too slow to tighten, timid, and we would all pay the price in the form of inflation rising out of control, and the Fed ultimately forced to play a brutal game of catch-up. The Wall Street Journal‘s post-meeting coverage in a page-one story announced: “Economists consider a ‘neutral’ Fed funds rate…to be between 3 percent and 5 percent. Investors expect the funds rate to reach 2.25 percent by the end of this year and 3.75 percent by the end of 2005.”

Just…plain…flat…wrong. After this morning’s news, the only game in town is egg-on-face, with ketchup, not catch-up.

At 6:30 a.m. EST today, the Labor Department released non-farm payroll figures for June, expected to have increased by 250,000 to 300,000 new jobs. Including a downward revision for May, the job gain was only 99,000, a weakish number for a strong economy, and way too low to continue the recapture of all the jobs lost 2001-2003. These monthly payroll figures are wildly variable across the baseline of economic growth, but the sorry June number had support: wages and hours worked were also on the weak side, and new claims for unemployment insurance have trended up slightly.

A bunch of other June data released this week were distinctly below the March-May red-hot performance: the purchasing managers’ index, construction spending, and auto sales. This new, lower-temperature stream of information does not suggest an economy about to stall out, but fears of overheating and out-of-control inflation have no foundation in reality.

With inflation risk now suppressed, and economic strength in question, the neatly geometric notion that the Fed would tighten in a straight line to 3 percent is in flinders. A replacement theory has already begun to show in the “yield curve”, the graphic description of spreads between short and long rates.

As the Fed begins any tightening cycle, long-term rates should rise with the Fed’s short-term one, until the long-term market thinks the Fed is getting close to causing a recession. In those moments, a Fed tightening is followed by a bond rally, a drop in long-term rates, as bond players try to buy in advance of the recession, always the big-time money-maker for bonds.

This week, the Fed executed its first tightening move, and got a bond rally. Granted, bond yields had risen a ton in expectation that the Fed was coming, but it is still astounding to find the bond market already driving down expectations of how high the Fed may ultimately be able to go before it kicks the stool out from under the economy.

Amazing, but here it is: the 10-year T-note was 4.7 percent on Monday, and it is 4.45 percent today. That’s not a mere change in the pace of the Fed’s March to neutral; it’s a bet by a hell of a lot of money that the Fed is going to have a hard time getting as high as 2.5 percent no matter how long it takes.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at


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