The Fed has begun to reverse its quantitative easing, letting MBS bleed out of its portfolio. Thus far, no effect on mortgages. We can tell because the spread between mortgage rates and the 10-year T-note has remained in historical pattern: add 1.80% to 10s on any given day, and get close to the 30-fixed no-point mortgage rate. And so mortgages are today, roughly 4.00%.
We are still in a data-vacuum, everything distorted by hurricanes. And what little data might be reliable is distorted by news-pushers desperate to find meaning and yell about it.
One sample: ubiquitous fear and prediction of a stock market fainting spell -- interrupted only by those expecting stocks to go higher. Perfectly normal.
The work of the newest Nobel Prize winner in economics, Richard Thaler is especially helpful today. Prior to his work, and dominant at the Nobel-heavy University of Chicago was the “rational expectations” school of economics. Since individuals are likely to make decisions in their self-interest, the rational behavior of large groups need only be detected in order to explain economic and market events.
Despite two decades of subversive academic thought, Thaler was appointed to the Chicago faculty in 1995 and has just about demolished “rational expectations.” His research shows that we are in fact, nuts. Or at least irrational.
“Behavioral economics” to me is little more than a parlor game, but Thaler’s insights go farther. Behavioral economics (BE) points out to us ad nauseum that we are frequently tricked by our own minds. Boxers have known for some time that if you hit an opponent in the belly over and over, the opponent will leave his head open to a blow. Or vice-versa. BE advocates present zillions of our hunches as in reality our own self-deceit. No boxer necessary.
The purpose of a good education is to teach us self-suspicion. Avoid hunches. Do not expect repetitive patterns to repeat in perpetuity. We are not prisoners to BE; it is one of our many choices.
Thaler himself is not immune -- as I’m sure he would agree with a laugh. One of his famous experiments: he gave coffee mugs to half of the students in a class, and then opened a market for mugs in the class. Students who had received mugs gave them value double that acknowledged by students without mugs, and Thaler announced the discovery of an “endowment effect.”
Those of us who work in markets will quickly tickle to the absurdity of the discovery. Does any seller of anything -- stocks, bonds, houses -- think the asset is worth less than the value placed by a potential buyer? Financial markets -- all of them -- have “bid” and “offer” sides. When they match we have a transaction. The rest of the time the bids are lower than the offers to sell, glaring at each other across an inevitable divide (spread), no trading. We might call that the First Law of Possessions. We don’t give away valuable things without compensation, whether altruistic or monetary, and the possessor values the possession more than the buyer. Which may be one of the few rational human activities.
Circle back to Thaler’s central point, well-demonstrated. We are nuts. What a perfect insight for today!
Neither markets nor businesses like uncertainty. As carefully as I can muster dispassionate commentary, financial markets are semi-frozen -- or perhaps better, in a process of congealing. As is some unknown amount of economic activity. Here is the shifting-sands list for today:
1. We live and die every day with IT, every market and business. IT has gone rogue, vast new computing power now used to destroy legitimate IT use. I don’t now how ugly or disruptive this is going to get, but it’s running downhill fast. The new head of Homeland Security is exactly the right person, Kirstjen Nielsen, an IT security expert. Google her and the info is so thin that she may not actually exist. So much for terror as the top threat; now it’s IT.
2. We do not know who the next Fed Chair will be. If it’s Warsh or Taylor, the slightest misstatement by either after nomination will blow up markets. Even Yellen’s re-nomination will have an effect (rates and stocks up). The new nominee is due any day, or who knows.
3. We do not know if we will have a tax cut or tax reform or tax shuffling, let alone what kind.
4. Deadly overseas developments are still not likely, but are more possible than any time in 15 years.
5. Trade policy is moving in self-destructive directions.
6. The Party Congress in China is likely to coronate Xi Jinping as Emperor For Life, or however much shorter or longer he would like. And nobody but Xi knows what he will do with more power than anyone since Mao.
7. The newest executive order on Obamacare is destructive to the spirit of many Americans, but we don’t know to what economic effect.
8. The go-along Republicans have trusted old-fashioned discipline: stay quiet and try to get done whatever can be done. The result has been to hand over the agenda to morning tweets, stream-of-consciousness speeches to the faithful, and radicals who would vote the go-alongs out of office.
US 10-year T-note. Given the Fed on the march, it’s hard to see how rates break out of the bottom of this range. And if it’s not the bottom, its going to be....
US 2-year T-note is the Fed telltale, December built-in. A new Chair, and who knows:
The small business surveyor, NFIB goes back to the early ‘70s, and its “optimism” question has been an excellent proxy for the whole economy. Until last fall. The Trump response has been durable, but faltering now -- as shows above in the chart of the 10-year:
Other components of the NFIB survey show sudden and significant weakness in business prospects. Possibly a hurricane effect, but not showing in other economic data. Possibly the first sign of Trump-weariness among the faithful: