We’re aday early because of a little local weather problem, but there’s nothing in asecond 3-foot snowstorm in one week to compare with the trouble brewing in thebond market.
The10-year T-note blew above 4.7 percent this morning on generally healthyeconomic data — that’s up from the 4.43 percent low three weeks ago, and willshortly put mortgages at 6.25 percent and at risk for a sustained move upward.
The datasince mid-month have not been all that strong, but enough to change thebond-market psychology from a debate about hard versus soft landing to softlanding versus no landing at all. Even if the economy does stay a tad soft,Gross Domestic Product growth in the 2 percent-something range, on current datathere is no reason to expect the Fed to cut its rate from 5.25 percent, andthat means that 10-year bond yields near 4.5 percent have been a tad silly.
As regularreaders know, the New Year ceremony at this rag is to recite Peter Drucker’sdictum: “Nobody can predict the future. The idea is to keep a firm graspof the present.”
Threeitems dominate the present — housing, risk and Iraq — and the word”spillover” is the key to each.
Housinghas been the center of expectations for a deep economic slowdown and theequally deep 2006 anticipatory decline in long-term rates. The financialmarkets have made two large errors in these expectations: they have assumedthat housing behaves like financial markets, and that housing weakness would dogreat harm to the rest of the economy.
Pricecorrections in financial markets happen fast, but housing moves at the pace ofmunicipal snow removal. Expectations today that housing has bottomed are justas poorly founded as the one six months ago that we would be buried inforeclosures by now. The thing to watch for: the development of a loan-defaultcredit-crunch spiral — that’s the only means for housing to get ugly enoughfor recession.
The seconderror has been the spillover one: surely, the markets believed, the end of thebig price gains would shock homeowners out of consumption and into saving.Surely all those ex-Realtors, ex-mortgage lenders, ex-construction workers,ex-Home Depot employees, furniture, rug, and appliance makers … surely thosejob losses would tip over the economy. Uh-uh. Nope. Not enough people involved,and the ones who have lost jobs have readily re-deployed.
The onehousing spillover at work: equity withdrawal is diminishing — a certainty in aflat-price environment — and that will tend to dampen the economy.
Risk is aneasy thing to measure in money land: you get paid for risk by higher return.Except … not now. Returns for risk over time or for credit or for liquidityare as low as they ever get, and all prior similar episodes have endedunhappily. Although that painful back-look has 100 percent accuracy, there isno way to know when risk premia might return to reasonable levels, or whatmight trigger risk re-pricing.
Iraq’sspillover into financial markets has thus far been small. However, the cost ofthe venture is going to begin to matter: in current operations, in deferredspending on equipment and maintenance, in manpower expansion, and in the needto cease starving other ventures (Afghanistan). Two choices: borrow, or raisetaxes.
Thefeedback potential from Iraq into risk is now substantial. Never before in ourhistory have policy convictions been so deeply held and so scattered withstakes so high, nor — rather worse — with so little probability of accurateanticipation of future consequences of any line of action.
The richespouring into markets and paychecks today are the return from the millennialexpansion in global trade, and that trade depends on stability.
LouBarnes is a mortgage broker and nationally syndicated columnist based inBoulder, Colo. He can be reached at lbarnes@boulderwest.com.
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Copyright 2006 Lou Barnes