We have interest rate and Fed surprises, but lost in all of that other stuff.
Long-term rates have jumped in the last 48 hours on hopes for a trade deal with China (which may be aided by all of that other stuff), and even a Brexit deal. The jump has several lessons about who pushes which buttons in which credit markets and with what consequences for real estate. 10s paid 1.58% on Wednesday night, now 1.75% and barely holding on. The Fed-sensitive 2-year T-note rose about the same, from 1.41% to 1.58%, but mortgages moved hardly at all, from a hair under 4.00% to 4.00%.
Who is in charge here? The big rate decline since August 1st has had foreign fingerprints throughout, and frightened foreign money typically goes to Treasurys, not to our weird MBS. The trade-tariff shootout has had much more damaging effect overseas than here, so with hopes for a trade deal overseas buyers dumped Treasurys and did little harm to mortgages. Another point of confirming data: since Wednesday long-term rates fell all over the world — German 10s were negative 0.59% on Wednesday, now negative 0.43%.
The 2-year T-note is not affected by overseas panic. Its unwinding upward in the last two days reflects everybody’s money resetting wagers on future Fed cuts. New consensus: maybe two by the end of winter, not three.
The spread between 10s and MBS often stays stable for long periods, retail 30-fixed rates about two percent above 10s — so predictable that consumers can easily check 10s and add 2.00% to get close to current mortgage rates without calling lenders and triggering a fibbing contest. However, in times of international upset the spread widens, and may also be affected by the Fed’s unwinding of MBS bought during QE. The Fed holds about $1.4 trillion MBS, rolling off now at a maximum of $20 billion per month — whenever a Fed-held MBS pays off (refi, home sale) the Fed now replaces it with Treasurys. The MBS market has to do without bigger, constant bidding by the Fed, possibly widening the 10s/MBS spread, closer to 2.20% going forward. (Note: today’s WSJ front page story on these widening spreads, “Superlow Mortgage Rate Could Be Lower” is a deceitful kneecapping of mortgage lenders.)
The forecast for interest rates is still low, reinforced by new information from the Fed this week but largely overlooked — crowded out by that other stuff, and media focused on the Fed’s internal divide between doves and hawks.
The deeper Fed news came in two pieces, first the minutes from the Fed’s September meeting. All of us try to conceal priorities from time to time, but slip and reveal them by accident. The minutes are thirteen pages of text, all but the first page devoted to the dove-hawk debate. That opening page for the first time in memory focuses on policy options if the Fed gets caught at zero again, the “effective lower bound,” ELB in Fed-ese. This first page has a dozen ELB notations. If the zero-trap is the first-page priority, perhaps it is the Fed’s deepest concern, and reason to keep policy on the easy side.
Then, supporting the thought of tilt-to-ease… Chair Powell spoke on Tuesday at a convention of economists. These rubber-chicken lunch affairs, just a few weeks ahead of a Fed meeting rarely tip the Chair’s hand. Coverage was appropriately routine, and focused on the top issues: the effects of trade war, and the Fed’s work to smooth short-term financial market lending. And missed something important.
Chair Powell, while having his ankle chewed by the president as never since LBJ is quietly bringing change to Fed thinking, change as big as any of his predecessors. One year ago, masked by communications error while still learning that job, Powell made clear his exhaustion with the Fed’s focus on overheating job markets. That preoccupation (Phillips Curve) had broken down as an inflation-predictor twenty years ago. Powell required a re-think, even mildly ridiculed the hawks stuck on the old, non-working model. We don’t have a new model (his speech described work on a new one), but we are free from rate-hiking solely because the unemployment rate is too low.
On Tuesday he required another re-think of a different issue, also cherished by economists. The equation governing the Fed’s economic speed limit has been: work force growth plus productivity gain equals non-inflationary growth, productivity defined as GDP divided by hours worked. If GDP heat raises the pay of workers beyond gains in productivity, the excess will be inflation. On Tuesday he blew up the traditional thinking about productivity, which has been slow and therefore reduced the Fed’s GDP speed limit and encouraged a tighter Fed than necessary.
Powell’s key observation on Tuesday: “Recent research suggests that current official statistics may understate productivity growth by missing a significant part of the growing value we derive from fast internet connections and smartphones. These technologies, which were just emerging 15 years ago, are now ubiquitous. We can now be constantly connected to the accumulated knowledge of humankind and receive near instantaneous updates on the lives of friends far and wide. And, adding to the measurement challenge, many of these services are free, which is to say, not explicitly priced. How should we value the luxury of never needing to ask for directions?”
Robert Kaplan, Dallas Fed president and perhaps sharpest tool in the Fed’s shed has been on the IT-effect trail since last year. In his essay this week: “The increase in technology and technology-enabled disruption is also putting a spotlight on the adaptive capabilities of the workforce. In surveys of 29 participating Organization for Economic Cooperation and Development countries, the U.S. ranked 20th in assessments of adult literacy and math skills. It also ranked 24th out of 35 developed countries in measures of math, science and reading skills among 15-year-olds.” An energetic politician might think to do something about that, especially in the depressed countryside.
To distract yourself from all of that other stuff going on, ruminate on IT and productivity. My generation is the last to be comfortable with maps (paper and mental), and prefer them to my car yapping at me. A college student barely 15 years ago needed a class to learn how to use a library. Not just the decimal system and card catalog, but research materials, gazetteers and encyclopedia… and then had to go to the library, find the book (unless someone else had it), and thumb physically through the pages, every page out of date by years or decades. Finding, loading, and scrolling archives… on microfilm.
And hard-heads worry about a shortage of productivity? Pshaw.
The Atlanta Fed’s latest was updated on Wednesday, and is based on changes in GDP components — there is no way to build a trade deal into its forecast. And a trade deal may not be as beneficial here or overseas as hoped. Other issues remain: