Cherry Creek Mortgage
Commentary 18 January 2019


The financial markets force us to sit still and listen to lessons. Which would not be so bad if the lessons were not so counter-intuitive. My ol’ daddy used to say that most human discomfort results from disagreement about priorities. We have ours, and markets have theirs.

Today’s lesson: markets care about resolution of the trade dispute with China. The Dow is up 277 at the moment, and at 24,645 up two thousand since January 3. Rates are rising, the 10-year T-note at 2.80% the highest since Christmas.

Deconstruct all of that. China resolution is just a rumor, no official White House stand-down. We’ve seen markets behave happily over and over in response to resolution rumors, and safe to say that markets do not care a whit why we stand down, just do it. Sure, we’d all prefer that China stop its intellectual property theft and non-tariff barriers to trade, but tariff bludgeoning does more harm than concessions would do good. Bilateral concessions come from long and quiet negotiation.

The stock market might care about the chaotic Brexit proceedings, but does not. Too soon. If the UK and EU have no idea of the outcome, or what they are doing, what me worry? Stocks might care about the new allegations against Mr. Trump...? Nope. Stocks have already built in everything that he is doing, including the shutdown, and besides -- what financial difference would president Pence bring?

Okay, happy stocks. But why are rates rising? Partly because of happy stocks, the threat of cave-in greatly reduced. However, every senior Fed official in the last ten days has elbowed to a microphone to advocate a pause in rate hikes. All included the demented “data dependent” (since when is it news to watch data?), but the biggest signal is the Fed hawks suddenly waving little white flags.

The Kansas City Fed historically has done one good thing: sponsor the annual conference in Jackson Hole. The Fed’s 10th district: of the twelve, only Dallas and San Francisco lie west of it, and the 10th includes Wyoming, Colorado, Nebraska, Kansas, Oklahoma, western Missouri and northern New Mexico. It includes only three significant metro areas: Kansas City, Oklahoma City, and vibrant and tech-heavy Denver.

It is by far the most conservative district, and flowing from that unique status is an unbroken record of error. All the way back through Greenspan the KC Fed has insisted that inflation is the imminent threat, today and forever, and opposed any Fed measure to stimulate the economy, no matter what. There is no polite way to characterize the KC Fed president’s dissents after Lehman in 2008 (Thomas Hoenig, 20 years KC prez).

Thus it was a big deal this week when its current president, Esther George said that “we are close” to neutral, and “...we should proceed with caution and be patient as we approach our destination.”

Ask again: if Fed hawks are flying in surrender formation, new inflation numbers down, why are long-term rates rising? Because they fell and overshot. The 10-year T-note fell from 3.24% on November 8 to 2.56% on January 3 (note non-coincidence with stock bottom). A rebound to 2.80% is a perfectly normal partial “retracement.” The Fed-sensitive 2-year T-note on the same dates fell from 2.98% to 2.39%, today 2.60%. The Fed’s overnight cost of money is presently 2.50%, and so the 2-year says no hikes in 2019.

However, revisit Ms. George’s words, in particular “destination.” (Not to needle KC -- no fun in piling on the defenseless). All at the Fed have forever pursued a “soft landing” at the end of every cycle of tightening, a destination of a kind. In the modern history of the Fed, post-WW II the Fed has achieved a soft landing once: 1995-1999. The self-congratulatory back-slapping then was enough to dislocate shoulders, the preening “great moderation,” which soon blew to flinders in the stock and credit bubbles. The one-time stability of the Fed funds rate in those few years should be dismissed as an accident, not skill.

Remembering that I’m a fan of central banks, we must daily remind ourselves of the limits of central bank power and foresight.

The Fed began to announce a specific target for Fed funds in 1994. Before that we had to read markets and Fed accounting to divine its rate target and even direction. So, examine Fed “destinations” since the mid-1980s, after the wild era of Volcker.

The Fed concluded a tightening cycle in December 1988 at 9.75%. The damage forced the Fed to ease exactly one year later.

Then in February 1995 up to 6.00% and cut five months later, but only to 5.50%, the beginning of those four years of relative stability. The Fed mistakenly cut to 4.75% in the 1998 currency crisis, further ballooning stocks, but then began rapid re-tightening to its destination in May of 2000 at 6.00%. That lasted five months. As soft landings go, even Sully crashed: in three years to 1.00%.

Then to another destination in June 2006 at 5.25% which lasted fifteen months. And was followed by seven years at 0.25% -- the effective rate far below zero because of QE.

The Fed runs a lousy airport. Although doing the best anybody can.

Looking at that history, many colleagues in the chattering-analyst class already insist that the Fed’s next move will be to cut. Maybe, but not likely and not soon. Ms. George may be correct that Fed hikes thus far merely get us out of a period of emergency low, and 2.50% is a destination which could last a while, or be a new baseline.

Until something happens. :-)


Since we’re talking long-term here, this chart is the 10-year T-note going back ten years. Add about 1.90% to get 30-fixed mortgage rates. Nothing in this chart suggests future direction:


The Fed funds rate going back to 1954. Actual dates of change here. At the end of Fed tightening cycles we have time for coffee and then move on. Down for a while. Never a “destination:”