Illegible Tea Leaves

With the credit markets reacting frostily to the Fed's QE2 program of buying up gobs of Treasury securities (roughly $75 billions worth each week until the middle of next year, unless economic changes—or intense political pressures—dictate a change to that schedule), interest rates showed an upward trend over the week. The average rate on the Freddie Mac 30-year FRM, in particular, climbed from the prior week's record low of 4.17% to a startling 4.39%. Measured from Wednesday through the following Thursday each week, this average mortgage rate should have our full attention.

Interest rates were buoyed by a few rather positive economic indicators as well.

Keeping in mind that the main thing needed by the real estate market to stimulate sales is that consumer confidence rise because of better job formation in America and by increasing retail sales. Thus, the slight decline in unemployment insurance claims—that is, in the 4-week average of new claims—gains a certain significance. In reality, new claims actually rose by 2,000 in the volatile weekly data. But the 4-week average showed a loss of 4,000, and that took the number total claims to 443,000, which is the lowest level since the first week of September, 2008.

This bears watching, of course. (Keep the corks in the champagne bottles.) But a feeling of greater optimism may be justified.

Earlier in the week, we learned that retail sales last month reached their highest level since August, 2008. This may be a harbinger of better-than-expected holiday sales and may foretell better economic growth.

It's good news, but as the frequent reader of this and other economic updates knows, such good news often translates into slightly higher interest rates. So here we have the source of yet more upward pressure on rates.

This is brings in the credit markets a great many borrowers who want to grab a low rate before rates rise still further.

So what are the inevitable "on-the-other-hands" these days? First, there are tremendous worries about the viability of the QE2 plan. Foreign critics seem worried primarily that America is trying to sneak an advantage for its exports by reducing the exchange-rate value of the dollar (and thus making our products less expensive to foreign importers). Needless to say, Fed officials have been vociferous in denying that they have this intention—though QE2 may possibly produce this result (among others). American critics worry about the level of inflation it may create.

Second, in any case, is the worry produced by Ireland's obvious fiscal problems. If you think the problem of getting Republicans and Democrats to agree on the same solutions to our debt woes is nearly impossible to overcome, consider what it's like when the challenge includes agreement among more than a dozen different nations. So, as The Economist notes this past week, the countries are making a mess of it. What we sense in the larger economic world is a huge sigh of relief whenever—as happened last week—it seems that a bail-out is being achieved…followed by fear and gnashing of teeth as it later becomes apparent that more needs to be done or, in the case of Greece, genuine economic recovery is much further away than most are willing to say.

Then there's the matter of China's rising inflation rate, and the possibility of price controls to keep it under control. More on that later.

With such counterforces, it's difficult to assume rates will continue to rise in a steady pattern. Nonetheless, the downward slide—and the Fed's ability to keep it in place—seem to have been at least temporarily broken.

by: Bill Fisher