Mortgage Credit News by Louis S Barnes - July 16, 2021

The bond market may show signs of a bottom, the 10-year T-note unable to break below 1.30% despite Chair Powell’s insistence on Fed patience as-is.

Powell is fully aware that he is playing with fire, his own and the Fed’s reputation at risk along with the economy, and dissention is rising among Fed underlings. The bond market is sitting beside the same fire, but poised for the exit.

The story this week is the mechanics of inflation and its Covid forecasting, and one of life’s most confounding questions: whaddya gonna do about it?

With apologies to Dr. Hawking, a brief history of Fed time. The Fed’s modern history began as the world recovered from WW II in the 1950s, and the increased threat of inflation in the US. Right and wrong for 70 years afterwards, the Fed believed in pre-empting inflation by creating recessions -- raising rates enough to throw out of work enough people to end any period of wage-pulled inflation.

During and after the Great Recession, 2008 forward, the Fed held the cost of money at zero, and in three long QE operations supported the supply of credit. At the tag end of 2015 Chair Yellen began the first oh-so-tentative liftoff from zero. When Powell took over as Chair in February 2018, the Fed had raised the cost of money to 1.40%, but Yellen’s caution had given way to a new consensus at the Fed: the need to “normalize” the cost of money, up to normal for full recovery.

For a full understanding of the black comedy involved, I can hardly wait for Nick Timiraos’ book on the Powell Fed due next winter. In 2018, nobody knew where normal was -- nor in the Fed’s entire history despite a fantastic mass of pseudo-math acknowledging that neutral was “not observable.” Powell appeared to go along with the hawk-centrist consensus, and in the next seventeen months, by July 2019 raised the cost of money to 2.40%. Long-term rates began to rise as well, and by fall mortgages anticipating more hikes got close to 5.00%.

By late fall 2019 Powell and everyone else knew they were normalizing their way into recession, and by November in an unseemly retreat un-did the last hikes, back to 1.50% cost of money, where we were upon the arrival of Covid three months later. In fall 2019, Jesuit-trained Powell in semi-insulting fashion blew up the baseless Fed theory of pre-empting inflation by throwing people out of work based on inflation forecasts, which had been consistently mistaken since 2000 when the world shifted from inflation-prone to deflation-tilt.

Powell’s new policy: we’re going to wait to hike until we actually see inflation. Do we see it now -- or do we see Covid effects which will take a while to fade but will fade?

Several analysts have offered a useful approach to the question. Instead of inflation as one great furball of aggregate statistics, or even traditional sectors (energy, food, housing and so on), examine today’s price movements by business sector. These approaches sound a bit like rumsfeldisms (Donald Rumsfeld died last month, he of the “known knowns, known unknowns, unknown unknows...”), but are basic questions facing merchants every day.

First. The category of items and services which fell in price at Covid outset, and are now recovering but to old baselines and not likely to spiral. Many commodities fall into this category, as well as manufactured supply. The return to baseline price is not inflation.

Second. Goods and services for which prices have slowed during Covid and may or may not stay slow: apparel, education and communication. Oddly enough, the steady and steep increase in the cost of medical care stopped with Covid -- perhaps because of the widely reported refusal of optional care, probably for fear of infection.

Third. A hazard zone: prices which jumped and may stay up. It seems likely that several categories of service work -- restaurants and retail -- will have to raise wages permanently in order to re-staff. A year-and-a-half of Covid disruption has given workers time to think about their work, and it takes an unprecedented jolt and time to change behavior.
Higher wages in these industries... it’s easy to argue that a one-time upward reset is a good thing, so long as not igniting a spiral.

Fourth. The dangerous, nobody-knows, spiral-prone categories: prices which jumped because of supply constraints and may or may not come down or stop rising. Autos, new and used. Oil and gas and gasoline. Housing is so weird that we do not have good measurements, the CPI determinant based on rents, which can’t rise beyond tenants’ ability to pay. Home prices are affected by land-supply issues having little to do with Covid or the Fed. Lumber is the bright spot, quadrupled and now back to normal.

Whaddya gonna do about it? I am amazed at the people who understood and agreed with Powell’s new policy -- enough of throwing people out of work for fear of forecasts -- but who now want the Fed to do exactly that. Brilliant and obnoxious Larry Summers. Brilliant and overconfident Jamie Dimon this week announcing a 10-year T-note rocket to 3.00%. Obnoxious and not brilliant James Bullard at the St. Louis Fed, who wants the Fed to tighten now. Some prices are up, some will stay up, but there is no sign of spiral anywhere.

Others, especially the hair-shirt mob on the Right think that the Fed and government have given too much money to America. They are also sure that the Fed and government are trying to arrange inflation in order to debase the dollar and inflate away our debt.

The Left, in power for the moment, is drunk on spending. Truly soused. And on climate booze. The threat is real, especially to sea level, but the climate activists refuse newkewler supply. And this week here and in Europe new plans for tariffs on imports from nations not sufficiently carbon-disciplined. Indonesia and Nigeria are the world’s 4th and 7th most-populous nations, and can’t eat without selling and consuming their oil. The world is fragile, Covid added to deflation and demography, better off if helped or left alone than fiddled with.

This is not a great time for public policy anywhere. Covid, instead of unifying our focus has exposed the deep lunatic streak in humanity.

Instead of the great Biden Spasm, $3.5 trillion trying to re-do the Great Society... why not commit to vaccinating the three or four billion of us too poor to afford the vaccine?

Loons... in just the last day, an un-vaccinated outbreak on the New York Yankees has canceled their series with Boston, and at the All Star game infected who knows how many other refuseniks. The AP reports that four NFL teams are barely 50% vaccinated, and only seven at 85% or higher.

The all-powerful 10-year T-note in the last year, yesterday and today’s trading added in green:

With thanks to Advisor Perspectives for these next two charts.