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Blog Details
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The Eye of the Storm
By
Roger Arnold
On
5/15/2009
Topics:
Consumer Confidence,Economy,Housing,Mortgage Rates
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The US equity run in the past few months has been impressive in its swiftness, as has been the rise in long term US treasury yields.
However, neither is indicative of a change in the economic trajectory.
There has been a slight decrease in some measurements of the rate of the contraction in economic activity in the US.
This decrease is the result of a structural "gap" in the debt markets.
The collapse of the subprime residential mortgage market which began in February of 2007 and accelerated throughout the year was the market catalyst for the crisis of confidence and cascading contagion in non-bank lending which also engulfed the banking sector starting last September.
Since then the rate of default on subprime mortgages has subsided along with the immediate "knock on" effects in the capital markets and economy overall.
This immediate reprieve is a capital market structural phenomenon, not an economic one.
In my opinion it is also indicative of extraordinary irrationality by market participants.
The subprime mortgages were on 2-3 year reset or recast schedule.
The majority of the subprime mortgage losses that may be taken have been taken and absorbed by the government''s intervention in the markets with monetary and fiscal stimulus.
This has brought the US economy to the eye of the storm.
The next wave of consolidations will center on the residential mortgages in the option arm and alt-a arena, along with credit cards, and commercial mortgages.
These three areas together represent a larger amount of outstanding debt that will be written off; it is a fait accompli.
The capital markets are not taking this inevitability into account at this point.
The ability to deny this next phase of the storm for the capital markets and economy will swamp the monetary and fiscal policies efforts to counteract them.
As a result, as the eye of the storm passes, and debt defaults begin to rise rapidly, the markets will again revert to reflecting the macro trajectory for the economy.
We will see stock market indices fall back to the lows of this past March and US Treasury yields to the lows of this past November.
The Federal Reserve, through quantitative easing, will attempt to force conforming mortgage rates below the recent lows and to as low as 4% par 30 year fixed rate, perhaps before the end of this summer.
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