Posted by Tim Lampe, Written by Steve Peterson, Incline Village Nevada

The tax discussions are already causing the credit markets to worry about looming inflation, and to act and react in certain ways. Interest rates have been rising at a significant clip, and it doesn't look like another of the credit market's momentary fancies. It may be that rates will continue their upward trend.

And we will hear more and more about the possibility of higher inflation. We already have the Fed's "quantitative easing" program in place, one of whose effects is to give a little boost to inflation in our nation. Economists also argue that the results of the looming tax deal will most likely include not only support for the economy but also a gradual lowering of the value of Treasury securities. Both are inflationary.

So it appears at this moment that interest rates are entering an upward trend. This isn't entirely bad, given that fixed-income investors have received so little return for so long. Further, the very recent huge purchases of municipal bonds by PIMCO's Bill Gross suggest that--in his view, at least--rates aren't likely to rise too far too fast. So I will be listening for anything Mr. Gross has to say in the near future. And on we go....

KEY INDICATORS [12/16/10]

 Gold $1401.60/ounce [down]

Crude Oil (Brent) $91.55/brl [up]

U.S. Dollar to…

    Euro .7577 [up]

    Japanese Yen 83.37 [up]

6-mo Treasury Bill Yield 0.18%

10-yr Treasury Note Yield 3.38%

[6-month up 1 bp, 10-yr up 30 bps]

11th Dist Cost of Funds 1.654%[-]

30-yr Fixed-rate Mortgage 4.95%

15-yr Fixed-rate Mortgage 4.33%

1-yr ARM 3.82%

[HSH averages rates: 30-yr

up 9 bps;15-yr up 7 bps; 1-yr ARM up 9 bps]

 

Mortgage Bankers Association Mortgage Applications Index

week ending 12/3

  Overall

    Down 0.9%; down 16.5%

the week prior

  Purchase Money Loans

    Up 1.8%; up 1.1%

            the week prior

  Refinancing Loans

    Down 1.4%; down 21.6%

the week prior

 

Jobless Claims 12/4

    421,000 – prior week 436,000  (rev) – total insured 4.086 million, down 191,000

 

Producer Price Index (PPI) Nov

    Up 0.8% month-to-month – with food/energy prices removed, up 0.3% (1.2% annualized)

 

Retail Sales Nov

    Up 0.8% month-to-month – without auto sales, up 1.2%

Weekly National Economic Commentary

Thanks largely to the likelihood of passing a “tax deal,” interest rates have been climbing at a rapid clip and analysts have brought worries about rising future inflation back into the economic discussion. It may at first seem just another swing—from concerns about possible deflation to anxieties about rising inflation, and back again—but this time the worries may have some staying power.

 The two central issues here are extensions of tax benefits—first to the unemployed, second to higher-income taxpayers. What is remarkable about these two central issues is that, taken together, they amplify a few worrisome possibilities for the economy’s future. Specifically, extending unemployment benefits expands the economy’s growth—a good thing but probably an inflationary thing. Further, foregoing receipt of higher taxes from wealthier citizens most likely means that we will have to auction ever more Treasury securities, also potentially inflationary.

 Now, a strengthening economy—and both of these measures should help the economy grow (in the short term, at the least) nearly always translates into higher inflation and, in anticipation of that, our interest rates will start to climb…as indeed they already have. Further, the likelihood of even more massive auctions of Treasury securities increases the near certainty that interest rates will rise (as demand for Treasury securities fails to fully cover the number of securities being auctioned; it’s a supply-and-demand equation).

 The credit markets don’t wait until after something has happened; they react in advance of whatever their investors believe will happen. Investors have begun to worry about inflation already and they anticipate that the seeds of higher interest rates are being sown. So Treasury securities interest rates are already on the rise, and they may continue to rise for as long as the tax deal is in place—or until something else captures the attention of traders, investors and economists.

 It is difficult to predict what, if anything, will grab the markets’ attention, so it seems relatively likely that the rising interest rate trend will be with us for quite some time. However, the bond guru Bill Gross of PIMCO Securities placed a $5.5 million bet on municipal bonds a few days ago. He apparently feels bond prices have fallen quite far and are likely to recover. (Bond yields decline as bond prices rise.)

 The takeaway here is that while rates are clearly on the rise and could continue to rise, the economy is still reacting to external forces—to government programs and legislation—and not to forces inherent to the current economy itself.