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Virginia Mortgage News - July 22 2005 |
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Mortgage rates are up again, moving steadily toward 6.00%, in lockstep as always with the 10-year T-note, itself marching toward 4.30%.
In a week without economic data, China’s currency revaluation and London terror got the ink, but the Fed was the real story -- and will continue to be.
China caught the markets unprepared on Thursday morning, a measure of its bankers’ increasing skill. If you’ve got something big to do, don’t fool around like a politician with leaks and preliminaries -- just do it.
The fact of the action was miniscule: a 2% increase in the value of the yuan. The portent is enormous: this revaluation is the first of many, many to come, and the event triggered a one-day wave of bond selling, receding and stabilizing today. This first revaluation was symbolic, designed to head off the idiot fans of tariffs in Congress, and other US critics of China’s willingness to feed our junk habit.
For now, and for some years ahead, our symbiotic relationship with China will continue, China taking overvalued dollars for its goods, selling cheap to run its economy hot (9.5% growth last quarter), loaning its export winnings back to us so that we will buy more. Yesterday’s revaluation marks the beginning of change in that relationship; at the end, China’s economy will be as free-standing as Europe’s, and will have no need to buy American bonds to subsidize more American consumption.
Cassandras abound, pointing to unsustainable trade and the risk that the dollar and Treasurys will soon be wallpaper. I doubt that. China bears the weight of a busted banking system; massive and bankrupt state-run industries; eight hundred million people in the countryside with $325 annual per capita income; state corruption; and is so frightened of its people that it censors the internet.
For now, China needs us more than we need it. There will come a time....
Mr. Greenspan this week made his last appearance before Congress (unless they invite him back for a victory lap and retire-the-trophy ceremony).
He delivered eight brutal pages, emphasizing strong economic growth and inflation risk, and in his unique style expressed total contempt for those buying long-term bonds at today’s yields. “History cautions that long periods of relative stability often engender unrealistic expectations of its permanence, and at times may lead to financial excess....”
His recitation of inflation threats -- rising unit labor costs, exhaustion of the benefits of productivity, and potentially higher energy costs ahead -- is as clear a warning as he can send that the Fed is nowhere near the end of its “removal of excess accommodation.” The markets have priced-in a 4.00% Fed funds rate (from 3.25% today) by year-end, but have not priced-in additional tightening beyond that.
Sez here, markets better get on with it, ‘cause it’s coming. I think the Chairman tipped his hand in his three-page discussion of long-term rates: he visited the heard-everywhere excess of savings and shortage of investment opportunity, but did not mention the “excess production and labor capacity” that everyone else uses to explain super-low long-term rates. I think he’s telling us that the world has returned to its pre-stock-bubble condition, and the Fed must follow.
1995-97, CPI was 2.7%, 2.9%, and 2.3%, and the Fed leaned against the economy at 5.50%. Deflation threatened in ’98, CPI fell to 1.5%, and the Fed eased to 4.75%. CPI rose to 2.1% in ’99 and 3.3% in ’00, so the Fed tightened to 6.00%, inducing recession. CPI in the last twelve months has risen 2.6%.
There are other measures of inflation, and other variables. However, listening to The Man, and looking back, I don’t know why the Fed next year should be significantly below the 4.75%-5.50% marking 2%-plus CPI in the 1990s... unless CPI fades, or something breaks.
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