Long-term rates rose last week as healthy economic data undermined ghoulish bond-market hopes for an economic downturn.
The 10-year T-note could not hold its pre-Thanksgiving rally to 4.4 percent and is now back above 4.5 percent; that trade eliminated the chance for mortgage decline toward 6 percent. Fixed 30-year deals are now back at the 2005 high, 6.375 percent.
Despite these retracements, the “topping” pattern in long-term rates is still in place. The Treasury 2-to-10 spread is still .1 percent or less, and at one point last week the 5-year T-note yield was slightly under Treasury 2s and 3s. That brief and minor “inversion” (a long-term rate under a shorter-term one) is a precursor for a larger and more significant one likely to develop in the next 60 days.
The Fed will go to 4.25 percent on Dec. 13, and most observers expect 4.5 percent on Feb. 1 — if the 10-year stays put, that would mean no spread at all from overnight money to 10 years. The Fed, of course, never wants to be caught as the cause of a slowdown of any kind, and so argues that the inversion developing now has external, different-this-time cause. Don’t believe it.
One of cosmologist Stephen Hawking’s greatest lines: “Time is what keeps everything from happening all at once.”
Just as the bond market got ramped up for a slowdown, here came a pile of economically positive data. In brand-new descriptions of the November economy, payrolls gained 215,000 jobs, and the twin surveys from the purchasing managers’ association ran hot. In lagged data, orders for durable goods in October doubled expectations, jumping 3.4 percent; and third-quarter GDP was revised from 3.8 percent growth to 4.3 percent — that despite Katrina in the third month of the quarter.
The headline number that really killed bonds was October sales of new homes — up 13 percent, and a sharp decline in the inventory of homes for sale. Many observers have since tried to discredit that sales figure (incentive-distorted, one-time…) and largely failed. New mortgage originations do not show a comparable surge, but are not tailing, either.
Expectations for a decline in the housing market are premature. However, that decline is inevitable, just a matter of time and extent. The main cause of inevitability: no market for anything can continue to compound at the rate that housing has. The national numbers are not much help, as they are an aggregation of dead flat markets (Greeley, Colo.) and screaming ones (Arizona up 30 percent in the last year), but the 12 percent increase nationwide in the last year cannot continue.
It can’t continue because of affordability, because Fed rates hikes are already doing damage, and because future hikes will do more damage. The world is full of false syllogisms, but I don’t think this one is: if a huge increase in home values has been central to a hot economy, then a flattening of prices will suppress the economy. (Ambrose Bierce’s favorite false logic: If one man can dig a post hole in 60 seconds, then 60 men can dig a post hole in one second).
Timing and extent. We don’t know — can’t know — if the natural divergence of price from income will do the trick, or if the Fed will, and we have no way to know if the slowdown will be gradual or painful. But it is coming.
I think the best guess for the consequence of the slowdown is PIMCO’s: expect it to be gradual, and expect the action to be in short-term rates. The long-term bond market already has built-in an ’06 slowdown; once it develops, the Fed will back off from wherever it stops, very much like the 1994-95 sequence of 3 percent-to-6 percent tightening followed by back-off to 5.5 percent.
It would take a substantial mistake by the Fed or a housing crash to get fixed mortgages way down into the fives.
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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