Friday, November 19, 2004

Real estate rates defy economic expansion

30-year fixed holds near 5.75%

By Lou Barnes
Inman News


Mortgage rates are still holding against pretty good October economic data, and against the Fed's obvious intention to raise its interest rate at least another percentage point as quickly as it can.

October industrial production doubled its forecast increase, up .7 percent, as did industrial capacity in use, up to 77.7 percent. October CPI and PPI core rates were just under control, up .2 percent and .3 percent respectively, but the energy-distorted nominals soared .6 percent and 1.7 percent. There are limits to core comfort at the Fed.

The bond market has construed $55/bbl oil as a powerful economic suppressant, and a price unwinding will remove some support for bonds. The current $47-$48 hasn't hurt, but a drop to the $30s would. There is evidence of constrained consumption, wholesale switching to coal, and increased production – here in Colorado, the drilling-permit count just broke the 1980 record and the 1990 Gulf War I peak, and is now triple the average of the late 1990s.

More data as strong as the last three weeks and bonds will have to consider a Fed pace faster than "measured" and/or a "neutral" Fed funds target above 3 percent.

All that taken in, the 10-year T-note holding near 4.2 percent and mortgages near 5.75 percent is a matter of considerable dispute, confusion and disbelief.

The currency market has been the dominant force in the bond market. Yesterday, the dollar fell to a new low against the yen, only 103/buck, and traders rushed to buy bonds, figuring the Bank of Japan would soon buy in order to drive down the value of the yen in order to preserve Japan's exports to the United States. Beating the BOJ (and other central banks) to the punch has been a recurrent interest-rate-lowering event, overwhelming worries about the Fed, inflation and growth. This downward tug on rates will continue until the world drowns in dollars, and then reverse with a vengeance. Unless...unless we can stem the dollar flood.

Currency markets are well nigh incomprehensible to civilians. Only insomniacs should try to figure out the details of dollar politics. The only things you need to know are these: we are running a trade deficit of $500 billion each year, and less than half of that is sustainable. Sooner or later, we will reduce our consumption of imports – will reduce, not "may." We have choices about how, but not whether: we may choose to save more as individuals; or we may save more by reducing our domestic budget deficit; or the Fed and markets will raise interest rates.

Take your pick. The first option is out by default: we aren't going to save as individuals because we don't.

To get the Federal deficit under control would mean a substantial, multiyear tax increase. The Bush administration will hear nothing of that: it has the triumphant blabs about simultaneous permanent tax cuts, tax reform, and Social Security and Medicare reform. "Deficits don't matter."

The administration's sole first-term legislative success was talking Congress into giving away three or four trillion dollars. Generally, bending Congress to that task doesn't take a lot of salesmanship. Given the administration's hard-headedness in the first term, the second may end before awareness dawns that its financial agenda is impossibly conflicted and dangerous.

The administration is pursuing the currency market option with all its attendant risk – first to Europe (damn near out of business at 1.3 euro/buck), to world trade in general, and then to ourselves. Federal Reserve Chairman Alan Greenspan's dollar speech this morning was pointed straight at the White House, but they don't listen to anyone outside.

In the long meantime ahead, the trade and domestic deficits will do their ugly compounding work, and strain in the currency markets will release in surprises.

Rates face upside risk greater than any chance for a decline.

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