The 10-year Treasury yield surged yesterday while the stock market sagged. The threat of higher long rates (the 10-year’s nearly 5.1% yield is the highest in four years) is becoming reality, weighing on equity and bond traders alike. But in keeping with the times, the long-anticipated rise in long rates arrives just as a cloud of debate descends over what the Federal Reserve is planning for monetary policy in the coming months.
The central bank may not be the most transparent institution on the planet, but few have been surprised by the continual string of 25-basis-point rate hikes that have prevailed since June of 2004. The absurdly low 1.0% Fed funds rate was last seen on June 29, 2004, a day before the FOMC declared it defunct by way of a quarter-point rise to 1.25%. The Fed has been making similar declarations ever since, and so Fed funds now stands materially higher at 4.75%.
The next opportunity for a declarative statement on monetary policy from Bernanke et. al. comes on May 10. Expectations for another 25-basis-point hike are baked into May Fed funds futures, but there’s also a rising tide of prediction that the tightening may be the central bank’s last for some time.
We emphasize “prediction” because this particular moment is proving to be tricky when it comes to deciding when the Fed will cease and desist with its rate hikes. Arguably, the main catalyst for expecting an end to the tightening will be a material slowdown in the real estate market. But by what definition will “slowdown” be decided? And when?
Whatever the answer, real estate is a sector that’s received a laser beam of focus recently over whether the bull market in home prices is a bubble threatening to burst until and if the central bank intervenes with sentiment-shifting incentives, i.e., higher rates. In fact, there’s been some recent evidence that the housing market has been cooling, if only marginally. But turning points in real estate, Fed policy, or any other economic/financial trend are rarely crystal clear, and the transition in housing from boom to something less is proving to be no less wily, and so the cloud of unknowing may be spilling over into the outlook for Fed policy.

The latest reason to pause before proclaiming that housing is suffering comes in yesterday’s update on existing home sales for March, via the National Association of Realtors. There was enough of a sales rebound last month, following a much larger upward surge in February, to keep investors guessing as to whether the Fed really will end its hikes in May.
“It’s a good sign to see home sales holding close to the level of a strong rebound in the month before,” says David Lereah, NAR’s chief economist, in a press release accompanying yesterday’s update. “This is additional evidence that we’re experiencing a soft landing. We may see some minor slowing in home sales as interest rates rise, but the market clearly is stabilizing.” Just to be clear, Lereah expects 2006 to be the third-strongest year on record for home sales.
Does that sound like the conditions that will convince the Fed end the rate hikes? And while we’re considering reasons to rethink when the tightening will stop, consider this: this morning’s new home sales for March also posted a tidy rebound last month v. February, according to the Commerce Department.
In addition, today’s durable goods report for March brings news of an exceptionally strong rise in this series by 6.1% for March. That’s above the consensus forecast of 1.8%, according to TheStreet.com.
Yes, much of the rise in durable goods comes from overseas aircraft orders, and so it’s questionable just how relevant last month’s pop is in the grand scheme of macroeconomic trends. Fair point, although it’s harder to dismiss the fact that March’s rise in orders follows February’s strong 3.4% ascent. In fact, durable goods orders have risen in five of the last six months. If this is an anomaly, it’s a persistently bullish one.
In any case, if divining the future path of Fed policy has been relatively easy in recent quarters, it threatens to become less so for the foreseeable future. A quantitative assessment of that perceived leap in opacity can be found in the estimated probability of various rate hike scenarios, courtesy of number crunching by the estimable Macroblog, which is run by an economics professor who also happens to work at the Cleveland Fed. On Monday, Macroblog noted that the implied probability of holding Fed funds steady at the June meeting have been falling recently while the odds for another hike in June had been rising.
In other words, confidence about comes next may be fading. Every new economic report now holds the potential to move the market, change perceptions, and alter outcomes. It’s getting interesting all over again.
© 2006 by James Picerno. All rights reserved.