Market Adaptation and Looming Inflation

The Dow Jones Industrial Average and the Standard & Poor’s 500 stock indexes both experienced a slightly better than 4% gain over this past week.  Mortgage bonds (and rates) suffered as a result.  Is this indicating a fundamental change in the direction of the markets?

 Yes, we are seeing a change.  But it’s not a change in the markets; it is a change in how investors have adapted to the markets.  They are STARVING for good news to the point where they will throw a party even when slightly-less-than-catastrophic news comes out.  It’s like the investors have selective hearing.  To give an example, CitiGroup announced today that they will be laying off 9000 employees and are suffering a loss of 5.1 billion.  How did the markets react to this ghastly proclamation?  With a standing ovation.  The Citi stock soared, in part catalyzing a substantial stock market rally today.

 The other rally this past week was Wednesday, when the Fed put out their Beige Book.  This is basi­cally a report of anecdotal commentary of current economic conditions taken by the Fed’s governors and key contacts. The report was slightly better than expected, though certainly not all rainbows and gumdrops.  Stocks leapt upwards as a result.

 So, with the contraction leveling off across many sectors, international business still humming along nicely and every newscaster dropping the line “market bottom” every hour on the hour, why am I not getting onboard the bullet train to Happytown?

 Because housing started this and housing WILL end this contraction.  Sadly, there is no indication of a market bottom for the housing and mortgage industries.  Loss of home values means many families lost their financial cushion and are tightening their spending to adjust.  Fixed mortgage rates are hardly any better than when this whole credit crunch started.  Existing and new home sales, numbers we will be getting next week, are projected to reach new lows (which isn’t surprising).

 In the minutes to the latest Fed meeting (released on Tuesday April 15th), Fed governors mentioned the potential for a “severe and protracted downturn” in our economy.  Inflation is rising at a consistent pace, albeit modestly.  Crude oil prices are climbing to new all-time highs.  Just today, oil hit a new intra-day high and a new closing high, both right around $117/barrel.  I remember at the beginning of this year when analysts were speculating that oil wouldn’t go above $100/barrel.  I guess the joke is on them.  Oh, and the joke is also on everyone who buys anything or travels anywhere ever. 

 And there is an inflationary tidal wave on the horizon.

 Demand for ethanol (which they derive from corn), foreign nations decreasing their food exports and a sudden increase of food demand from emerging markets has allowed food inflation to get out of hand.  Oil prices continue to spur fuel inflation.  We haven’t even begun to feel the true effects of dropping the Fed Funds Rate by 3% in 7 months and when we do, there will be too much money chasing too few goods.  When the market turns around, the money that has been sidelined by fear will pour back into the markets, creating a momentum driven capital infusion and will rapidly overheat our economy.

 And every taxpayer is getting $600 just for being so gosh-darn handsome on top of it.  Ain’t that nice?

 What does this all mean for mortgages?  Well, rates jumped upward this week.  I am confident that they will bounce back down to levels of previous weeks.  But not too much better than that.  It does send a clear signal that once the stock market starts to recover in any noteworthy way, mortgage rates will go up.  This “low low” rate environment will be short lived unless the Fed reverses course and raises rates once this credit crisis ends.  If they keep benchmark rates too low for too long, our bullet train to Happytown may be unexpectedly diverted to Skyrocketing Prices City.

 But at least we have the Pope for a couple of days.  He’ll make us feel better.

Leave a Reply

Your email address will not be published. Required fields are marked *