Mortgage Credit News by Louis S Barnes - August 27, 2021


Rate risk is tilted upward, now. Below... Powell and the Fed today, inflation thinking, Democrats in action, and Afghanistan.

Chair Powell. The Jackson Hole conference flipped to virtual -- too bad for attendees -- but Powell delivered opening remarks this morning.

It is risky to divine the contents of meetings not attended, but there is an evident gap between Powell and a near-majority of hawks. Jesuit-trained Powell is a precise man with words, and this sentence makes clear the divide: “I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.”

Could. Not should or likely or on the balance of risks. Meanwhile the predictable hawks among regional Fed presidents (the KC Fed always wants to tighten; Harker, Philly; village idiot Bullard, St. Louis) have been joined by several ordinarily sensible regionals (Kaplan, Dallas; Bostic, Atlanta; Rosengren, Boston). Their recent writings are not insightful, just the old and tired inflation-fighting instinct without attention to the many different kinds and aspects of inflation.

Two Fed policies are in play: QE4, the purchase of Treasurys and MBS likely to taper this fall, and second the liftoff from zero-percent money. Powell’s remarks on liftoff reinforce the sense of divide at the Fed, and were so dovish that Treasurys are a hair better than in advance of his remarks.

“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test... maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach....”

Powell may not have a majority with him. In the modern era the Fed governors (appointed by the president and confirmed by Congress) stay with the chair, revolts rising from regional Feds. But even Powell’s vice chair Clarida this month was far more hawkish than Powell today.

A little data... From July, personal income rose triple the forecast, 1.1% in the month, the wild miss proof that we don’t understand the Covid economy. Rescue payments bloated the figure, and will diminish soon. Personal spending was close to forecast, but a paltry 0.3% for the month. The “core personal expenditure deflator,” the Fed’s preferred measure of inflation has not slowed, still 0.3% in July, similar to June and in Clarida’s zone of alarm.
Delta is the largest unknown, clearly a force of slowing, but Delta’s disruption of supply chains is the central force of inflation. If these rising prices are “inflation.”

Inflation. Dangerous inflation is the wage-price spiral, in which they chase each other but after a while wages pull prices. That was the 1970s. Never before in modern US history (not since Civil War greenback-printing), and never since. But boy, howdy are we on the lookout. To get that wage-pulled spiral going, an absolute precondition: little or no foreign competition for US labor.

The Fed embraces the phony science of “inflation expectations” by focus on bond trading (inflation-protected bonds versus not, and tail-chasing swaps), but with some merit consumer and business behavior. As a merchandise manager in the 1970s, a routine task was to over-order our needs. Shoot, if we had too much, we’d sell next year at higher prices. If you see that, let someone know. If you can find a banker to finance excessive inventory, tell somebody.

Housing is the most credit-sensitive industry, hence the sacrificial one. However, only once since forever has housing been a generator of inflation. If you guessed 1970s, you win the rubber duckie. In that decade the Depression-remnant Fed Regulation Q still capped the maximum rate paid to depositors, and caused S&Ls to loan trillions of dollars of mortgages at rates below inflation. That lost-to-history accident is the source of “inflation is good for real estate.” Hardly. Ever since, any whiff of imaginary inflation has caused an over-reaction at the Fed, higher rates and a bad time for housing.

At the Fed, even Kaplan who used to look wise, and several others have embraced a new syllogism. We are far short of adequate housing supply, underbuilt since the great mortgage tightening after 2008, and prices have risen to non-affordable levels except for IT whizz-bangs and kids with fortunate parents. Therefore, proper Fed policy should stop buying MBS and encourage higher rates so prices will stop rising. A truly unique solution to affordability: jack rates so that nobody can buy or build. Voila! Inflation cured.

Opposites of wage-pulled inflation are supply or price shocks, or the two together. The two oil shocks in 1973 and 1979 were extreme. Say that again: extreme. Oil in a six-year span jumped tenfold four bucks/bbl to forty. No economy could adapt to that, simultaneously add to supply and conservation, and the. The Fed had to tolerate some inflation, or we were going to live in caves. It took seven years for oil to stabilize at double its pre-’73 price.

Nobody knows how long these supply disruptions will last. But it makes a lot more sense to give them some time than to quick-draw a recession.

Democrats. The $3.5 trillion budget “framework” has made it through Congress but not decided anything final. Its most-odious aspect is to punish ordinary long-term investors by calling them “wealthy” and raiding their capital gains before and after death. The party has control of government by the thinnest of margins and still seeks to force progressive projects without majority support among the people.

California’s legislature voted this week to un-do single-family zoning statewide. Progressives oppose Powell because he is insufficiently climate-friendly, and will not cut off credit to fossil-energy producers. The Supremes squashed the ban on eviction, and Dems still can’t figure out how to get the $50 billion in appropriated aid to tenants in need.

We are just a few months from pre-election bi-partisan freeze, which may be a good thing.

Afghanistan. Now, mostly a political matter. Joe is weakened if only by preoccupation, and the worst of that is losing control of his own party on other issues. The Right is howling because that’s what both parties do when they smell blood. Opponents of pull-out say we could have stayed forever with minimal forces, or that we could have done it better.

It does not look as though the country is buying any of that. Humiliated, wishing for a better way, but nobody has made a sensible case for a better way.

Our military presence in the Middle East and Central Asia since the 1960s has been a local irritant beyond any benefit and the principal creator of terrorism. We are needed in the Persian Gulf, which everyone there knows. We can strike at threats quickly and then come home, as we might have after the first year in Afghanistan.

The 10-year T-note in the last year, today’s trading added in red, a little better because Powell could have been worse. Could not have been better. The double-bottom at 1.19% is big, as is the inability today to get back below 1.30%. A move to 1.40%, and a run back to 1.60% becomes likely:

Oil and inflation and recessions (in gray) in two charts. The top one is in nominal dollars -- the cost/barrel in dollars of that day. BTW: I doubt that $60/bbl and four-buck gasoline is the new normal. The second chart is inflation-adjusted, all prices in 2021 dollars. I was there in 1973 and 1979, and today ain’t that.