Mortgage Credit News by Louis S Barnes - June 18, 2021

This week some juicy stuff. A little data, then The Big Fed Story That Wasn’t.
Data. Economic news is still chaotic and will remain so for many months as the many Covid disruptions resolve. Retail sales fell 1.3% in May in a nonsense report: sales were 28% above May 2020 and 20% above May 2019. But we measure sales by dollars, not units, and temporary pops in prices make sales look stronger than they really were.
Isn’t this inflation? In a time of odd scarcities (where are medium trash bags, and not-red 16oz plastic cups?), nobody discounts the price of anything in demand. No, we won’t pay cash to you if you will buy this car. Restoration of normal supplies will likely produce price-reversals. Lumber is one poster child: from long-term normal $400/board-foot to $1700 in early May, fir has free-fallen to $894 today, hoarders dumping.
New weekly claims for unemployment insurance jumped back above 400,000, giving strength to bonds and pushing down on rates. These are new losses of jobs, running double the pre-Covid level.
The Fed. The good entertainment began on Wednesday with fright. Markets were tape-bombed just after noon.
The origin of “tape” is tickertape, the throughput of tickers which brought the first e-news to investors and traders in 1886. And decorations for parades for heroes. The tickers disappeared in the 1960s, but “the tape” stuck as the term for the flow of news which began to stream at the bottom of new-fangled CRT screens. A tape-bomb is a bad-news surprise.
The Fed’s June meeting broke at noon on Wednesday with release of its post-meeting statement, forecasts, and newest “damned little dots” scattergram of Fed officials’ hunches of the location of the cost of money in the future. Within minutes financial media began to shout, “FED TO HIKE SOONER!”
Ten days ago to widespread surprise, the 10-year T-note yield broke below its three month trading range, 1.55%-1.75% to 1.44%. On Wednesday the tape-bomb blew the 10-year back to 1.58%, back into the old range, and by all market metaphysics should quickly have tested the old high at 1.75%. Instead, black comedy....
I can imagine chair Powell and other Fed officials saying to themselves, “We said what? Did I blow it again and give a bad signal to markets?” Powell’s press conference followed the meeting on Wednesday, and he certainly knew the market convulsion, but there is nothing in the transcript about the market, a change in Fed plans, or anything noteworthy. He acknowledged that recovery and prices are moving up faster than expected -- which everyone has known -- but stuck to continuing calm belief in transient price increases.
Our generation’s best Fed-watcher (best by miles), Nick Timiraos is writing a book, not available to say, “Wait a minute...!” Media stayed packed in their mistaken herd. After a night of investor homework and checking for actual damage, first thing Thursday morning the 10-year yield began a straight-line drop to 1.47%, and closed back down in its new range.
This morning another drop began, but intercepted by another tape-bomb, this one by James Bullard, the 13-year president of the St. Louis Fed, who intoned importantly that the Fed would raise rates sooner than expected. 10s jumped to 1.51%. Getting a make on Fed personalities is not easy, takes time and a certain unkind skepticism. Bullard’s bomb had short effect, barely an hour. Insiders and old-timers hold Bullard in low regard, a long history of self-important bloviation and zero insight, on his best day auditioning as Obviousman!.
The 10-year is back to 1.45%, on the edge of a new drop, helped also by a stock market air-pocket. If recovery and prices continue to out-perform, of course the Fed will move sooner. Everybody knows that. But the Fed is not on hair trigger. It wants to see, needs to see things play out, like lumber.
Inflation expectations. In the Fed’s forever struggle to forecast inflation, “expectation” theory is central, comes in two forms and does not work. The first form relies on signals from financial markets: comparing the fixed yield on the 10-year to 10-year inflation-protected Treasurys, and other truly arcane fiddling with swap-market maturities. Many fossils like me think that these signals are circular, markets imagining the future and trading accordingly, but not predictive. They are also handy tools for adding to client fright and inducing trades. A revealing chart is posted below.
The second form of expectation theory does have validity, but little if any predictive power: surveys of consumers and businesses. Validity lies in true changes in behavior. In the 1970s wage-price spiral, businesses earned good money by buying and carrying excessive inventory, even at excessive prices which were sure to go higher -- “inventory profit.” We had not sold the goods, but the value went up. Consumers bought quickly irrespective of price increases because prices would go higher. And wage-earners demanded higher pay, trying to leapfrog prices already risen. That time was the perfect example of inflation magnifying itself by future expectation and changed behavior.
Today we have none of that. China leads our world of over-investment, over-capacity, and over-production. IT for 25 years has made it impossible to raise prices and gross profit margins because the merchants willing to undercut are too numerous and too easy to find, which likewise compresses wages.
Consumers may elevate their hunches of future prices, but that’s a meaningless factoid unless they act on the hunch, ‘70s-style.

The 10-year T-note, just Wednesday through Friday. The tape-bomb fake is clear after lunch on Wednesday, the strong reversal on Thursday, and Bullard’s little adventure on Friday marked with a red tag:

The damned little dots... each one placed by a Fed regional president or Congress-confirmed Fed governor. There are a dozen regional Fed dots, but no more than half of the presidents are competent (they are appointed by local boards, often inbred). Each dot reflects the expected fed-funds rate at the end of each year. Maybe a hike at the end of 2022, likely not. The dots in 2023 reflect the uncertainty facing everyone. Based on the last 25 years, the “longer run” levels are ridiculous, the last try so high almost causing recession and followed by hasty retreat. One actual change: the rate labels on the Y-axis have moved from the left side to the right side:

Market-based expectations... from 2004 forward (the whole length of the series) this chart has actual core CPI in green versus 10s/TIPs “forecast.” One problem: inflation has been so low and steady that there is little to forecast. We might make a case that 10s/TIPs was a leading indicator for one sudden drop, but several false signals just on eyeball are more entertaining noise than a useful forecast: