We’ve just witnessed either a massive, pre-emptive, wholesale sentiment shift in the bond and MBS markets or one heck of a dress rehearsal.

Like the old EF Hutton commercial, when Bill Gross speaks, the markets listen. To those that missed this, Bill really detonated the destruction by suggesting that the US of A could lose its AAA debt status. It was all downhill from there.

Inflation at its core IS a monetary event and when the supply is increased, it is inflation but for all practical purposes, is it really? For in reality, it ultimately depends on the environment. 

Even a limp balloon becomes full in a vacuum but let the atmosphere back in and it’s still just another shriveled piece of rubber. Alternatively, put that balloon in a pressure vessel and you’ll realize that it’ll take a lot more air than usual to inflate it. 

By all accounts, we’ve seen the abyss or at least teetered on the edge. It’s only by way of massive stimulus (and plenty of hot air) that we’ve avoided the plunge. Have we now gone too far and to the point that a deflationary environment and Armageddon are just soon to be forgotten hitchhikers in the rear view mirror? Does it really happen that quickly?

Don’t get me wrong please, those that know me understand that I’m only a couple T-bones short of pure bred perma-bull, but I also bear the scars of the branding iron. I’ve learned my lessons by being there and though I’d love nothing more than to see an end to our current crisis, I also feel the foundation is not yet cured. Low rates, while artificially colored and flavored, were just beginning to have the intended effect. We’ve only just begun to grill that burger and there’s a lot of pink left on the flip side.

Maybe I’m just an idealist and would like to see the nation’s homeowners all locked in at 4.5%, maybe I just like helping people achieve that or maybe I’ve studied the past well enough to know that the likelihood of significant inflation occurring immediately post recession or unless hindsight proves differently, still in the midst of one, would be a phenomenon by classical definition. 

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Looking at the chart above, we can see that inflation (orange field) is nowhere to be seen, in fact, we’ve been in a deflationary environment and unemployment (red line) has propelled its way close to double digits. Absent the skew of the birth death ratio adding rather than subtracting jobs and the real rate is even worse. Each instance of recession (grey verticals) has seen inflation and thus interest rates continue to abate, often for a year or more after the end.

In simple terms, this is not the classical environment during which rates should rise. 

So what gives? Well if you’re old enough to remember, think Heinz 57 and Carly Simon.

Markets will move in anticipation of current fundamentals and policy leading to the most popular collectively expected results.  In other words, if we print more money, it’s worth less and investors or lenders demand higher yield.

Head Fake or Pipeline Cleansing Pause?

I’m still more bullish on housing than I am on stocks and the “V” shaped equities recovery we’ve seen can still become a “W.” If that happens, then we may very well see a renewed flight to safety,  lower bond yields, the continuance if not the further expansion of the Treasury MBS purchase program and don’t say it too loudly – lower mortgage rates.

Are these necessary for ultimate recovery, NO. Would they help further the nascent stabilization we’ve begun to witness with sometimes deeply discounted homes going to truly qualified buyers, YES. Would they help enhance the needed confidence for the shell shocked or side-liner’s urge to get back in the game, YES. Would they provide a continued enhanced family cash flow so that dollars currently servicing debt could be freed to fuel saving, discretionary spending and investment, YES. Would the lower interest rates actually help the government by increasing the taxes paid by homeowners but doing so in a way that benefits debtors directly by still lowering overall outlay, YES. Would they further benefit the government by simply lowering the cost of financing the national debt, YES.

Regardless of what would be nice, if what we’ve experienced is truly collective expectation acting as a barometer of coming economic growth, then let it rain. However, if all of this is the negative consequence of too much stimulus and not enough sizzle then let’s hope that recipe can be tweaked in a way that better enhances and defines the escape plan, brings strength back to the dollar and provides for rates more truly in line with realistic expectations for forward growth. For with sustained rates at a level that allows everyone eligible to lock in durable affordability, we’ll have truly created an environment that will foster a balanced and healthy housing market.