Bond traders are not idiots.
I’ve blogged about this before. People that invest in the bond and stock markets tend not to be completely stupid, in my experience. They do listen to CNBC. They do read the paper. They’re not unaware of what’s going on in the markets.
Everyone knows, for instance, that the Fed is going to phase out its purchase of mortgage-backed securities (MBS – it is these securities that lenders use to set their mortgage interest rates). Everyone knows that this phase-out is set to occur on or about the end of March. Today, Fed Chairman Ben Bernanke announced that the phase-out would be dependent on “the markets”, by which he presumably meant the homebuying markets as well as the bond and stock markets. In today’s testimony he gave no indication that there would be a dramatic, one-day-we’re-buying-the-next-we-aren’t cessation, and in fact he reaffirmed that the Fed would still be willing to buy MBS to keep interest rates low. But he also left intact the plan to stop buying, and sooner rather than later.
So…why aren’t we seeing a dramatic selloff in bonds? Are traders deaf? Are they insane? I mean, if Toyota were to have a huge recall of its cars (I know, like that would ever happen) and suddenly start bleeding money, its stock would fall like a rock. Oh. Wait.
Similarly, if one knew ahead of time that a dramatic decrease in the available purchase demand was in the offing, wouldn’t one be selling ahead of a price decline? Well?
Unless something weird happened in the last five minutes while I’ve been writing this, I think we have three things at work here that are currently more powerful than anything the Fed does, at least as regards the bond market, and, by extension, mortgage interest rates.
- The homebuyer credits. Uncle Sam has decided that handing over fistfuls of cash to people in exchange for them buying houses is a good idea. At least, it’s a good idea for another couple of months (see full details on the homebuyer tax credits here). That is, no question, stimulating demand for housing and for mortgages. That is firming home prices, and that firming holds out hope that there won’t be an eventual half of all homes in foreclosure (the best predictor of impending foreclosure is home equity – the more, the better). As fewer homes are in foreclosure, the mortgages that back those securities have more value, meaning that MBS are worth more.
- The economy sucks. Yeah, yeah, GDP is roaring ahead by 6%. Whatever. Anyone believe that number? Anyone? Bueller? Look, until people start being hired, and the hemorrhaging in the job market stops, no increase in nominal GDP – even assuming, for a moment, that the government figures didn’t begin with “once upon a time” – there is not going to be enough strength in the “recovery” to have any measurable impact on anything. Bad economy=bad for stocks=good for bonds.
- And finally, the big one – we all know that Bernanke isn’t really in control of anything. What year is this again? Oh, right, it’s 2010. Let’s see…even numbered year…ratcheting up of commercials…huge increase in bloviation from Washington…AH! That’s it! It’s an election year. The party in power is reeling from a series of straight jabs to the jaw along the once-reliable East Coast, and that increases the pressure on the DC elites to make sure the economy isn’t getting observably worse coming into November. Think the Fed will be increasing interest rates in the late summer? Pardon me, I’m going to have to get some supplementary oxygen from laughing so hard. Traders know who is really calling the shots in the financial system, and it isn’t Tim Geithner, nor is it Ben Bernanke. Any serious fiscal responsibility will have to wait at least a year.
Result? No big selloff in bonds at this point. No big moves in any direction. Traders are waiting for #3 to move before they do. Another stimulus (this time, it’s Stimulus III – The Jobs Bill) is possible, even likely, and that will change things. There is a gigantic overhaul of the entire financial system stalled in Congress right now, but it could get legs again now that health care appears too politically toxic. That also would dramatically change things.
Not being a prophet, I can’t tell you what will happen in April. Perhaps we’re in for a (long-overdue) spike in interest rates. But me? I’m not betting that way. And neither is Wall Street.