Mortgage rates are still holding between 6.5 percent and 6.75 percent for the low-fee deals, but the financial world moved this week into a realm of uncertainty, inflation risk and volatility that we have not seen in a long time.

Early in the week, markets traded in happy belief that the Fed is about to halt its rate increases, perhaps concluding after a 16th hike to 5 percent at its May 10 meeting. Bonds woke to reality on news that March “core” CPI had jumped the fence, but the party roared on in stocks and commodities.

Stocks finished at a six-year high, in largest part because everybody knows that every time the Fed stops a tightening campaign, stocks have a great run. That has been true in normal Fed cycles: the Fed tightens into an overheating economy, crushes it into recession, stops tightening, and the perfect time to buy stocks has been just before the Fed begins to ease into the ensuing recovery.

Very cool, but this cycle is unlike — in many ways the polar opposite — of all preceding modern cycles. The Fed will have raised its rate 4 percent over the last two years, but has not been “tightening,” merely returning to neutral range from a 50-year-low emergency easing.

The hope that the Fed will soon pause or stop altogether was fueled by the release of the minutes of its March meeting, which contained a brief, anonymous and wandering debate about the risks of raising rates too far, reinforced by public blather this week by a Fed governor (Yellen) who might better have corked it.

I think the inflation game has changed for the worse — maybe temporarily, maybe all OK if the economy slows down quickly, but worse. In this last year, oil prices have blown almost to 1980 levels (on inflation-weighted terms, today roughly 70 percent of that all-time price) and the “core” rate of inflation has held near the Fed’s 2 percent maximum-tolerance zone. Now, for the first time in this energy cycle, March brought a monthly core CPI value annualizing to 3.6 percent, and the threat that energy costs are percolating into the rest of the economy.

It’s only a single-month reading…yeah, yeah…BUT: oil is now solidly above $70 and much more likely to go higher than to repeat the post-1980 two-thirds collapse in price and 20-year stability. Hu Jintao is in town, but nobody seems to notice the little, back-page sidebar charts of China’s near-future demand for oil. Where is the world going to get another 10myn/bbl/day, in addition to sustaining the 82myn/bbl/day we run through now? The world is going to price-up until substitutes and conservation alter today’s way-excess demand versus limited supply.

The oil shocks of 1973-1980 taught the Fed (I hope) that it cannot tolerate a little inflation; all it will get is more, and once “more” moves from prices to wages it is hell on earth to squeeze out of the economy.

The Fed’s May 10 meeting is now a setup for the return of the true, up-and-down volatility common in the bond market before the artificial stability induced by the Fed during 2003-2006. This will be the first meeting in years at which the governors will have to exercise judgment, the mechanical reversal of emergency easing now a pleasant memory. A rookie Chairman accustomed to academic debate will have to decide on action and build a consensus.

Pause at 5 percent, waiting to be bailed out by a hoped-for slowdown? Wait almost two months until the next meeting to announce a pause, before or after 5.25 percent? Take out some pre-emptive insurance by sounding tough with a new inflation warning in the post-meeting lingo? This uncertainty is a prescription for some considerable back-and-forth in a bond market that has in the last 60 days gone from grudgingly conforming to the Fed’s overnight cost of money to leading it.

If the Fed guesses wrong on the easy side, bond yields will explode.

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

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