Mortgage rates saved from hike

Friday, June 04, 2004

By Lou Barnes
Inman News

Another very healthy employment report this morning should have taken mortgage ratesabove 6.5 percent, but we have been rescued by a new charm offensive from theFed.

Maypayrolls gained 248,000 jobs, close to forecast, but the immensely strong,652,000-job gain in March and April together was revised upward by anadditional 75,000 workers. Employment is increasing in all sectors, in hoursworked, in overtime, and in earnings.

The bondmarket immediately sold off, taking rates higher, then stabilizedand thenrecovered, mortgage prices no worse than yesterday, and some cases better.Talking economic heads have struggled all day to explain the absence of damage,like the baseball player who couldn't figure out how the ball wound up in hisglove. A common attempt held that the employment report was a"Goldilocks" deal: not to hot and not too cold a nice line, but nottrue. This is not some transient hot flash leading to economic menopause: thejob market is on fire, and so were all other the data this week, from thepurchasing managers' indices to retail sales.

Othersalvation arguments: despite recent job growth, there is still so much slack inlabor markets that inflationary growth in wages is not a risk. OK, but theFed's 1 percent rate is still very stimulative, and will remain so for six monthsto a year after the 18 months it takes the Fed to get all the way to a neutralrate (such is the inertia of monetary policy). Do we have two or three years'of to-be-hired labor on hand, at this growth rate?

Nope.

Anothereverything-is-okay: excess capacity in the economy will stave off inflationarypressure. Capacity-in-use is still only about 77 percent, way under the 83percent-85 percent worry zone; however, how much of the capacity not in use isnow obsolete and in the process of being abandoned? Example: how busy is theol' VCR factory?

The Fed has spent the last90 days preparing the bond market for the sustained increase in rates that willfollow the expiration of its previous charm offensive, the "considerableperiod" one. The Fed has told us that this new regime is "likely tobe "measured."

"Measured"is preferable to hasty, scurrying, frantic, lurching or hysterical, most ofwhich applied in 1994. "Measured" feels comfortable as to frequency(rate hikes at each Fed meeting, maybe, or most), but leaves me queasy as todistance. Perfectly precise measurements could include hikes of .5 percent(there was more than one of those in '94), or .75 percent (Greenspan's careerrecord, also in '94).

The Fedstepped in twice this week to intercept these traditional bond-market fears.The chairman, in a letter to Sen. Paul Sarbanes (D-Md.) said that the Fed'shistorical approach is not a useful guide in this situation because prices arelikely to increase much more slowly than in the past. Today, Fedgovernor Donald Kohn, very close to the chairman as a staffer, said that therewas "no major inflation threat" and that the Fed could be"gradual" in its return to neutral.

I don'tunderstand why the Fed is so confident that all these inflation signals are nota problem, but I sure like "gradual" that speaks to frequency anddistance.

Bill Gross,principal deity at PIMCO, thinks the Fed is behind, and must tighten .25percent at each of its four remaining meetings this year, and the Fed fundsfutures market agrees, plus a hair. The bond and mortgage markets have notpaused because of Goldilocks news; they have paused because they have built inas much damage from the Fed as is possible to discount at this time.

Once theFed gets going, the markets will begin to discount continuing measuredgradualism in 2005, a process that should begin on June 30, and shortlythereafter take bond and mortgage yields up the next notch. Gradually.

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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