The Government's Newest
Interest Rate Conundrum
by
Mike Larson
Step
into my interest rate time machine for a minute, if you
will. We're going back to February 16, 2005 — the day
former Federal Reserve Chairman Alan Greenspan testified
before the Senate Banking Committee.
The
topic of the day was the broader economy.
But
the biggest issue addressed, from the bond market's
perspective, was the infamous interest rate "conundrum."
The term referred to the odd reluctance of long-term
interest rates to rise, despite the Fed's steady and
persistent campaign of short-term interest rate hikes.
Or
as Greenspan explained at the time ...
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Today, the government wishes it only had
the problem former Chairman Greenspan faced on
February 16, 2005. |
"Long-term interest rates have trended lower in recent
months even as the Federal Reserve has raised the level
of the target federal funds rate by 150 basis points.
This development contrasts with most experience, which
suggests that, other things being equal, increasing
short-term interest rates are normally accompanied by a
rise in longer-term yields ...
"For the moment, the broadly unanticipated
behavior of world bond markets remains a conundrum."
Boy
would the government like to have THAT problem again!
Today, we face a different — and far more dangerous —
conundrum: Despite plunging short-term rates ... despite
falling rates on U.S. Treasuries ... mortgage rates are
NOT falling. In fact, the past few months, they've been
going UP.
Two roads diverged in a bond market world:
Treasuries and mortgages decouple ...
Take
a look at these two charts. One shows the yield on the
30-year U.S. Treasury Bond. The other shows the average
rate on a 30-year fixed mortgage, courtesy of the Mortgage
Bankers Association. I have shown roughly six years of
history for both.
You
can see that for the early part of the 2000s, the patterns
look very similar. When long-term Treasury bond yields
fell, so did long-term mortgage rates. When long-term
Treasury rates went up, so did the cost of borrowing to
buy a home or refinance a fixed mortgage.
But
look more closely at what has happened in the past year,
and you'll see something entirely different ...
Treasury rates have plunged — with the 30-year bond
recently yielding as little as 3.97% in early October.
That undercut the "deflation scare" low of June 2003
(4.17%). In fact, it's the lowest yield in the history of
the 30-year bond!
Yet
30-year mortgage rates have gone sideways to up. From a
recent low of 5.5% in January, they have climbed to 6.26%
as of late October. That is nowhere near the deflation
scare low of 4.99%.
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This is happening DESPITE the government's takeover of
Fannie Mae and Freddie Mac.
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This is happening DESPITE the Treasury Department's
pledge to buy Mortgage Backed Securities in an attempt
to artificially suppress mortgage rates.
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And this is happening DESPITE a whopping 425 basis
points — or 4.25 percentage points — in Fed rate cuts.
A
conundrum? You bet! And not a beneficial one, either.
The lesson?
No one — not even the government —
is more powerful than the market ...
For more than a year now, we have been bombarded with
government bailout packages.
We
have seen interest rate cut after interest rate cut.
Our
elected officials (and the unelected policymakers at the
Fed) have seen fit to spend hundreds of billions of
dollars in taxpayer money — our money — to save
Fannie Mae, Freddie Mac, AIG, and Bear Stearns.
They
are handing out $250 billion to everyone from Citigroup to
SunTrust, even helping banks merge in transactions
partially funded with our money.
And
yet, by this one crucial gauge — the cost of a 30-year
fixed mortgage — the government and the Fed have failed to
achieve much of anything. The lesson is simple: No one ...
not even the government ... is more powerful than the
market.
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Bond traders throughout the world are
worried about the quality of U.S. borrowers. |
Worse yet, fear is spreading throughout the world
...
Market players — mortgage bond buyers — are worried about
the direction of house prices. They're concerned about the
credit quality of U.S. borrowers. This is filtering into
the price of mortgage bonds, and keeping yields elevated.
Foreign investors, who used to snap up every last mortgage
backed security and corporate debt security sold by Fannie
Mae and Freddie Mac, appear to be backing away somewhat.
Concerns about the precise nature of the government's
support of Fannie and Freddie are also driving the two
agencies' borrowing costs up. That, in turn, puts upward
pressure on mortgage rates.
Another reason for higher rates overall: Concern about the
long-term fiscal position of the U.S. The government has
committed more than $1 trillion to all of its various
bailouts — and the list of companies begging for taxpayer
money gets longer every day.
Insurers want the same kinds of government-funded capital
injections that banks are getting. GM and Chrysler want
government money to help them merge, close factories, and
fire thousands of workers. Home builders want fresh tax
credits to spur purchases.
You'd think at some point that officials in Washington and
investors on Wall Street would get it. You'd think that
they'd understand the only solutions to the credit mess,
the deleveraging, and the real estate bust are simple:
Time and price. You simply can't cure the
popping of a multi-year debt and housing bubble by waving
a magic wand — not even a $1 trillion one.
For
stock investors, my prescription remains the same: When
you get government-fueled, short-term rallies, you should
look at them as opportunities to SELL. Or if you're more
aggressive, use them to add inverse ETFs or put options on
the cheap before the next leg down.
At
some point — once the unwinding is complete, once the
recession has run its course, and so on — THEN I think you
can start to bargain-hunt and bottom fish. But now is not
that time, in my opinion. The conundrum is still very much
with us.
Until next time,
Mike |
