Market Forces and Market Intervention

Stocks sprinted higher on Tuesday, releasing the pent up demand that developed over the long weekend.  The Dow rose 106 points.  According to several headlines we read, Dow stocks were boosted by strong housing and consumer confidence reports.

Then, on Wednesday, the market gave it all back…the Dow fell 106 points.  Easy come.  Easy go.

Yesterday the Dow picked up 26 points and the Japanese Nikkei 225 crashed 483 points.  But, despite the stock market’s erratic movements, something else caught our eye.  We watched in awe Tuesday as the yield on the 10-Year Treasury Note jumped to 2.13 percent.

No doubt, watching treasury yields move about is as dull as watching paint dry most of the time.  But occasionally, there’s some dramatic action.  What’s more, this may be one of those occasions.

For example, on May 2 – less than a month ago – the 10 Year Treasury yielded just 1.63 percent.  Since then yields have gone practically straight up…yields have jumped 30 percent just this month.  Could this be the beginning of the end of the great big Treasury bond bubble?

It Can’t Last Forever

Don’t ask us.  We’ve been predicting Treasury bonds will collapse – any day now – since George W. Bush still occupied the White House.

But regardless of whether the Treasury bubble’s finally popping or not, rising yields could suck the wind out of the budding housing recovery.  Or, at the very least, rising yields could derail the refinancing gravy train for mortgage brokers.  CNBC reports

“A sharp rise in mortgage rates over the last few weeks means it may already be too late for many homeowners to benefit from a refinance.

“This just as thousands were gaining equity in their homes and finally becoming eligible.”

Plus, in addition to restricting refinancing, rising mortgage rates could undo the Fed’s handiwork…

“The Federal Reserve has poured billions of dollars into the mortgage market since the housing crash began, pushing mortgage rates to record lows, but it can’t last forever. Recent remarks by Fed Chairman Ben Bernanke suggest the monthly mortgage market infusions may end sooner than later.

“That has pushed the rate on the 30 year fixed conventional mortgage to 3.90 percent, the highest level in a year and dangerously close to the emotional 4 percent barrier.  This as home prices are jumping higher and faster than expected.”

Market Forces and Market Intervention

When mortgage rates rise purchasing a home becomes less affordable.  Thus, for the market to clear, home prices must come down.  Dan Green, a loan officer with Waterstone Mortgage, figures that “every one percentage point rise in mortgage rates reduces the average home buyer’s purchase price by 11 percent.”

On Tuesday it was reported that, as measured by the S&P Case-Shiller house price index, March prices rose 10.87 percent on the year.  Note that in May alone mortgage rates rose 0.3 percent.  If they climb another 0.7 percent, using the figure that Dan Green provided, house prices will have to come down 11 percent to stay in balance with the average home buyer’s purchase price.

In other words, if mortgage rates rise to about 4.6 percent the 10.87 percent year over year increase will be wiped out.  Then where have the Fed’s antics gotten us?

Market forces ultimately overcome market intervention.  They clarify absurdities created by the Fed in an effort to bend the world to their liking.  Like 10-Year Treasuries yielding 1.4 percent.  Like 30-Year mortgage rates at 3.5 percent.

These are the sorts of distortions you get when you stand in front of a funhouse mirror.  They’re so absurd all you can do is point, laugh and guffaw at the inexplicable stretches.  Regrettably, once the world has adjusted to fit these deformities it must once again adjust when they pop back into place.  These adjustments are often painful.

Stay tuned!


MN Gordon
for Economic Prism

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