by Lou Barnes
Inman News
In dueling recoveries, mortgage rates have recovered despite more signs of economic recovery.
Make no mistake about which recovery has the greater power: the mortgage one is at best a technical recovery, and a strong economic recovery would overwhelm the mortgage market. Until we find out whether – or to what degree – the economic Sunshine Boys are correct, the bias in mortgage rates is upward.
The newest data show claims for unemployment insurance falling from the weekly centerline near 430,000, which prevailed for five months to 390,000 in the last three weeks. Retail chain stores reported a good July.
That’s it. That’s all we know, though 3rd-quarter GDP growth estimates run from 3 percent to an explosive 5 percent-plus.
While we wait for the economy to declare itself, two tactical lessons of the last month are worth absorbing. Both will be useful again, soon.
The first is simple, but emotionally difficult to deploy. Modern mortgage-portfolio hedging will cause any large move in mortgage rates, up or down, once underway to overshoot equilibrium by a half-percent or so before retracing. In ‘98 and ‘01, many people failed to lock in down-side overshoots, hoping for better in a free-fall. Instead, once you pick up .25 percent-.375 percent from the prior low, pull the trigger.
Contrariwise, in a big up-side panic, be patient (easy to say…), and you’ll have an excellent chance to catch a retracement. There are times when borrowers should join a panic, but those times are distinguished by high or rising inflation and an aggressive Fed (‘73, ‘79, ‘81, ‘87, ‘89, ‘94, ‘99)—not now.
The second lesson in market tactics involves the renewed budget deficit. The Treasury does its long-term borrowing (as opposed to weekly T-bill sales) in quarterly “refundings.” Nobody gets a refund, but the Treasury is said to “re-fund” itself. Since the Treasury began massive refundings in the early ‘80s until the surplus developed in ‘97, a reliable market pattern developed, and it returned this week.
Each refunding is a Tuesday-Wednesday-Thursday cycle, with two- or three-year notes auctioned on the first day, the five-year on Wednesday, and the 10-year on Thursday. The Fed is the auctioneer, collecting bids each morning, and awarding bonds to the low bidders at midday. The bidders are limited to three dozen “primary dealers,” which would like very much for bond prices to fall before the auctions, and rise once the auction is complete, like bidders at any auction.
In nearly every heavy-deficit auction in my memory, on each Tuesday afternoon the dealers claim that the auction of the short notes went badly. “Near disaster…Not enough bids…No retail…Dealers are stuck with the notes” – propaganda designed to keep bond prices down, which continues into Wednesday, until the Fed announces the results for the intermediate notes. Then, four times out of five, a rally appears by magic, prices rising and rates falling, despite the dealers’ continuing propaganda effort to hold down prices for the 10-year auction on Thursday.
No matter what else is going on in rate-land, don’t lock a rate in the week before a quarterly refunding, or on the Monday or Tuesday of the fact. Wait until noon on Wednesday: if a rally develops, as is likely, ride it into Thursday evening or Friday morning, and no longer.
However, if the bond market is sinking after the five-year results on Wednesday, lock anything you can, as you have suffered the misfortune of the fifth day out of five, and rates will rise right through the auction, and beyond.
The Fed meets on Tuesday. Some things are worth trying to outsmart, some not. The Fed won’t do anything, but Greenspan has lost his touch with the jawbone.
—Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at [email protected].