To: Michael Young who wrote (3098 ) 6/16/1999 3:03:00 AM From: michael r potter Respond to
-OT- Interest rates: Two main drivers of the economy are housing and autos. Mortgage rates are 7.50% plus. At this level, which is really quite high compared to inflation, new loan originations and new housing starts should taper off slowing economic growth [There has been a surge on new mortgage applications of late, because as rates surge up, a lot of fence sitters jump in befor they go higher]. Mortgage re-financings have fallen off a cliff after being very strong this past year and contributing to economic growth by freeing up more disposable income which was spent. The decision to buy a house or car is also a function of confidence. The great capital gains experienced by investors has been a strong driver of unexpectedly strong housing. If I am correct that the long bond at 6%-7% is a limiting factor in for the overall stock market, capital gains generation will be reduced which will also impact the consumers ability and willingness to take on a large commitment especially housing. Auto production which has consistently been above forecast and is a large component of our economic growth will be impacted if consumers are no longer getting those large capital gains. With Y2K issues looming, combined with high "real" interest rates, consumer confidence could take a dip in the months ahead. Slower economic growth would lead to lower long term interest rates. In essence, long bond rates and their impact on housing, autos, and other big ticket items will/are sewing the seeds of their own recovery which is one of the reasons to be long term bullish on bonds in the 6% to 7% area. Discussions, comments, and fixation on the Federal Reserves possible moves are of little substance, other than the agreed upon psychological impact. Often the media states that bonds were/are down over concern over a possible Fed tightening. The Fed sets short term rates, the market sets long term rates. If the Fed raised rates by 2% tomorrow would that be good for the bond market or bad? It would be great! The economy would slow dramatically cutting demand for credit and snuffing any inflation building in the economic system. Bonds would rally, long term rates would tumble, as inflation is the arch enemy of bonds. The reverse would be true if the Fed. cut rates by 2%. When the Fed. meets later this month, if they don't raise rates or only raise them 1/4%, the bond market won't be pleased. A 1/2% increase is what the bond market wants and while there might be a short term knee-jerk bond market sell-off, it would be followed by a strong rally. The market has already priced in a 1/2% increase, and anything less won't be positive for the bond or stock market. One wild card in the bond market is the extent of [hedge fund] involvement in the yen carry trade. Borrowing short rates in Japan and buying US treasuries which yield much more. This is typically done with much leverage. In the past two weeks the yen has appreciated substantially against the US$. This is bad news for the carry trade and part of the increase in rates of late [decline in our treasuries] may be attributed to unwinding of those positions. This and other similar factors somewhat outside our system could make rates overshoot to the upside creating an excellent opportunity to buy bonds. The bond market also sets the tune for our stock market priced for near perfection, which is why it is so important to watch and understand it [and ignore much of the medias mindless chatter-except for its impact on investor sentiment]. thanks, Mike
