Mortgage Credit News by Louis S Barnes- July 12, 2019

Long-term rates found bottom this week and began to rise. Not necessarily a new trend or lasting bottom, but a new episode in the never-ending effort to explain to civilians: long-term bonds and mortgages frequently fall in advance of Fed cuts in the overnight cost of money, and then rise upon the actual cuts.

The US 10-year T-note set its low on July 3 at 1.95%, then fiddled near 2.00% as during all of June, then yesterday popped to 2.14%. This is a global adventure: German 10s bottomed at minus-0.382% and now have risen to a one-month “high” (this is ridiculous) at minus 0.210%. US mortgages are now just above 4.00%.

There is more to the bottom-and-rise than routine reversal of Fed-anticipation. Two things: in the very short run an inflation surprise reported yesterday, core CPI up .3% in June, the year-over-year up 2.1%. Even in soggy Europe, German and French CPI rose .3% in June, 1.6% and 1.2% respectively for twelve months. If inflation is rising toward targets, why the global central bank urge to ease?

The second player in this week’s rate-rebound is the black sense of humor among the Gods of Bonds. The ancient Greeks understood these things, and saw the Gods acting through humans. Chair Powell has found his public game, better every time he appears. He gave this riff to Congress: “The relationship between the slack in the economy or unemployment and inflation was a strong one fifty years ago ... and has gone away,” broken 20 years or more ago, the forces are “...weaker and weaker. In addition to that... the neutral interest rate is lower than we had thought and... the natural rate of unemployment rate is lower than we thought. So monetary policy hasn’t been as accommodative as we had thought.”

Two things about that second issue. As correct as Powell is, and gratifying to a lot of us, might not the Fed have discovered the change 15, or 10, or 5, or even one year ago? We churls of bonds are ungrateful. The second aspect of Powell’s New Law: the Gods laugh when they put words like those into our mouths. Having failed to discover the change for twenty years, might it now be history? Not fake news, but expired?

If you announce the death of the Phillips Curve and low unemployment as a cause of inflation, the Gods are then amused to give you inflation. Or something else. The Fed is fully aware and nervous that deep easing from here risks asset bubbles. Note the lunatic joy of the stock market at prospective rate cuts necessary because the world is falling apart.

We still do not have evidence of a faltering US economy. However, we have unanimous central bank opinion that trade issues and risks to global growth justify easing. With thanks to Nick Timiraos at the WSJ, here is Mark Carney’s July 2 speech and charts, a brilliant, easy read. Carney is Governor of the Bank of England, previously of the Bank of Canada.

If not in the US, global data shows fractures opening, drops in trade volume and business confidence. And thanks to some other excellent WSJ reporting, we know of the worst banking crisis in China in a decade, a well-nigh Lehman event following seizure of Baoshang bank. A run followed, just like ours 2007-2008, not old folks lined up on sidewalks but banks running on other banks. China has an easier time putting down such events than we do: either stop liquidating collateral or spend the rest of your days making small rocks out of big rocks while the loudspeaker plays “The Wisdom of Xi Jinping.”

Stopping a run is one thing. But after Lehman it took us a half-dozen years of painful liquidation and capital-raising to restore our system. To have a run in super-controlled China at all exposes the large and rotting mounds under the lobby carpets of China’s banks, bigger and bigger as China slows with global trade.

Believe the central bankers, and be careful what you wish for. A trade meltdown would bring lower rates, but trade since 1990 has been the all-time global engine of wealth. There are other risks, sure -- inflation redux, the euro, Japan -- but nothing compared to trade.

Try as I must to keep politics out of financial commentary, the only reason that global trade is at risk is Mr. Trump.

We use the cliché, “the elephant in the room” to describe something too indelicate to discuss. We pass beer and chips to each other between its legs, and try to watch the game on TV around it. This particular pachyderm has an explosive digestive disorder, trumpets more than the average tusker, and its volatile personality leads to stomping guests and its own mahouts.

In the seats of power, safe from observation or quotation, what do senators and others say about containing risks from its upsets? Are they silent, like the living room?

Two inside examples this week. During Chair Powell’s week of Congressional testimony, several Representatives and Senators (including Richard Selby, R. Alabama, critic of any active Fed) made very clear that Powell has nothing to fear from the president. Congress does talk in private, and is prepared to intervene but we must guess when and how.

Second, the comic opera murder of the UK ambassador, Sir Kim Darroch. Sir Kim wrote to his Foreign Office characterizations of the president which everyone knows: “We don't really believe this Administration is going to become substantially more normal; less dysfunctional; less unpredictable; less faction riven; less diplomatically clumsy and inept.” But added, he may “emerge from the flames, battered but intact, like Schwarzenegger in the final scenes of The Terminator. Do not write him off.” Sir Kim’s report was hacked and released (Russians?).

These reports are routine for all ambassadors, as is criticism of presidents. If any other modern president had gotten such treatment his response would have been, with a wide grin: “The newspapers say the same thing about me!” Or Congress, or the opposite political party, to genuine bipartisan laughter. Reagan or Kennedy might have said, “I will spend more time with the ambassador, and show him my good side.”

This president? Stomp. “The wacky ambassador... A very stupid guy... A pompous fool....” Stomp, stomp. Trumpet.

Here we are, a grave risk facing the global economy caused by one man and leaders can’t discuss it in public. But at least out here we know what to watch.

China may be open to a fig leaf of trade deal, but it will not involve kneeling. Same for threats to Europe. For the economy and markets nothing matters except stand-down in this trade war.

The 10-year T-note in the last year. The Fed has done nothing since December, bonds and mortgage rates falling far in front:

Thanks to WSJ and Refinitiv, this is a chart of China inter-bank rates, in serious meltdown after seizure of Baoshang on May 24, no bank willing to lend longer than 14 days except at penalty rates. China will stop the panic, but it will take a generation to fix its banking system and it has not really begun:

Two charts from Mark Carney’s speech. Stand down the trade war and most can reverse: