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When Fed raises short-term rates, pray long-term rates don’t follow

By February 27, 2015 One Comment

Federal Reserve Chairwoman Janet Yellen’s testimony, inherently a forecast, overwhelmed all other forces on markets this week.

Yellen did a fabulous job. When the future is deeply uncertain, it’s the job of the Fed chair to turn on the fog, and she did — in an expert rundown on the issues, and the most detailed Monetary Policy Report ever issued, but conclusive fog.

Next week, reality returns with the Institute for Supply Management’s February indices and payrolls.

When will the Fed liftoff from 0 percent? We know less now than before she spoke. One long paragraph laid it out:

“If economic conditions continue to improve, as the committee anticipates, the committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis.

Right. Firm grasp of the obvious, but timing and slope of increase lost in the mist.

“Before then, the committee will change its forward guidance.” (We’ll drop “patience” before we hit you.)

“However, … a modification of the forward guidance should not be read as indicating that the committee will necessarily increase the target range in a couple of meetings.” (Great. We’ll drop “patience,” but may still be patient.)

“Instead the modification should be understood … a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and … the committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.”

Translation: We are desperate to get off zero. We’re going to pull the trigger before inflation is anywhere near a danger zone, years before. All of our modeling says we are behind the economic growth curve, and bubble risk is in both bonds and stocks.

Are we right to lift off? Every instinct says so, but these are very bright, observant and self-skeptical people — that is, Yellen, the appointed governors and Vice Chairman Fischer, and regional Presidents Dudley, Rosengren, Williams, Evans and Lockhart. (Ignore the other regionals.) They know the global economy is different than in any prior cycle, and they know that they cannot know in advance how a different world will interfere with previously routine cyclical shifts by the Fed.

Markets reacted well to Yellen at first, misunderstanding her as dovish. Uh-uh. Markets since have resumed a kind of deer-in-headlights low volatility. They don’t know what to watch. We in the bond market, the deer, have found calm in thinking Fed hikes will be very slow, and that overseas money will continue to pour into the dollar and U.S. bonds because of our yield advantage, holding long-term rates down.

If you felt a chill this morning, you deer, New York Fed President William Dudley delivered this line at a monetary conference: If long-term yields stay low after the Fed starts to raise its short-term rate, he said, “It would be appropriate to choose a more aggressive path of monetary policy normalization.”

That’s deadly, and not noticed. It has been one thing to think the Fed might ooch up the overnight cost of money, mild bubble-prevention on a long road to “normalization” (location unknown, but perhaps way below the traditional 4 percent), and entirely another to think the Fed wants to push up long-term rates.

That’s us, deer. Housing. Push up mortgages past 5 percent in this economy? What in the world for? Housing is too weak as it is to lead the economy. And homeownership is the last shot that the average American has to build a net worth someday.

Try these stats: The rate of homeownership 20 years ago was 64 percent, rose to 69 percent, and is now straight-lining down below 64 percent. Rental vacancy was 7.5 percent 20 years ago, rose to 11 percent in 2011, and is now below 7 percent and falling. Median rent in just 10 years has jumped from $600 a month to $775 and rising, versus flat incomes.

Quibbling with inflation stats is a dead end, except in one place. The consumer price index (CPI) includes housing cost, NOT prices. In fact, 40 percent of CPI is housing. Core CPI year over year is 1.6 percent, but excluding unaffordable rent is below 1 percent.

Housing, including the effect on tenants, is a drag on this economy. I have a ton of respect for the leadership of this Fed, but speaking as a deer the prospect of jacking long-term rates out of historical habit, or to avoid Greenspan’s error 2003-2006 in a completely different financial world … crackpot.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at

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