Friday, July 21, 2006

Mortgage rates fall after Bernanke's speech

Fed chief says economy is 'moderating,' but outcome may be worse

The 10-year T-note is again falling toward 5 percent, and has taken low-fee mortgage rates to 6.75 percent

Newspapers today say that "mortgage rates rose" this week, but this factoid is based on Freddie Mac's bone-headed method of early-week survey and delayed (Thursday) release. Rates had risen in nervous anticipation of Federal Reserve Chair Ben Bernanke's Wednesday testimony to Congress, but fell instantly -- before he began to speak -- on release of his prepared remarks.

Bernanke's communication skills are improving: the testimony was as bland and even-handed as could be. However, the heart of his testimony, and the strong reaction in the bond and stock market, were odd. Bernanke, now repeatedly referring to a "moderating" economy, offered a forecast of GDP growth to decline from "3.5-3.25 percent in 2006 to 3.25-3 percent in 2007," and core inflation to decline from "2.5-2.25 percent in 2006 to 2.25-2 percent in 2007."

Oddity number one: a centerline decline in GDP growth of .25 percent from 2006 to 2007 is too small to measure, the insignificant over-the-weekend change in the waistline of a binge eater on a diet.

Number two: how would a .25 percent GDP moderation reverse the obvious inflation problem at hand? Bernanke seems supremely confident that if oil stabilizes here, inflation will gradually abate without economic sacrifice, and stock and bond markets gleefully agreed.

Number three: Bernanke indicated no particular angst that core inflation has crawled out of its 2 percent box. When one senator asked him his reaction to inflation above the 2 percent target, he snapped, "We have no target."

I think you get a post-testimony bond-buying surge like this only if the market believes that the economy is going to moderate a hell of a lot more than Bernanke's .25 percent, and that if the Fed goes to 5.5 percent on Aug. 8 it will result in deeper moderation -- ideally, a recession.

Now, there's nothing really odd about that line of thought. It is, after all, the standard, end-of-Fed-cycle, bond-market dream of Christmas. And, in the short run, the bond market is always more worried about the Fed than inflation. If the Fed sounds as tough is done, it's safe to buy bonds.

The deepest peculiarity here is the absence of caution in the market, especially the bond market. The worst moment for bonds in a hundred years was the 1970s, during which the Fed tolerated the gradually rising inflation pushed by energy costs, refusing to inflict the economic pain necessary to keep inflation in the box. Inflation ultimately spun out of control altogether.

Read the entire Lou Barnes article at Citywide Services

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