New Home Sales Drop Hard, Stock Prices Nosedive, Bond Yields Soar

The Commerce Department released figures on Monday showing that new home sales fell by more than nine percent in January to just 1.11 million units, far exceeding analysts' expectations of the cooling off in the new homes market. Although some economists dismissed the bad report as showing nothing more than the effect of bad winter weather, most agreed that the drop was a significant indicator of underlying softness in the economy beginning to show up in major expenditures.

With interest rates steadily climbing in recent months, the cost of borrowing by both households and businesses has risen to the point where financing big-ticket purchases is becoming more and more challenging. Aside from Monday's news about new home sales, last week the Commerce Department reported that durable goods orders fell in January, giving further evidence that the rising interest rate environment is beginning to slow down the economy in material and worrisome ways.

The Federal Reserve Board has been pushing up short-term interest rates through both rate setting and through open market operations,

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The Federal Reserve is executing "open market operations" when it sells Treasury securities to, or buys them from, banks to change the amount of lendable money in the banking system.

both of which are to the end of combatting inflation that the Fed still claims is under control. By pursuing tight monetary policy, the liquidity being drained out of the economy causes interest rates, which are the price of money, to rise. This attack on inflation has the secondary and undesirable effect of dampening consumer and business borrowing, which adversely affects the economy as a whole and individual consumers and businesses, too.

Stock prices took a round thumping today, with all of the major market indices dropping hard. The blue chip index lost nearly three-quarters of a percent of its value, and the NASDAQ lost about two-thirds of a percent of its value. The broad-based sell-off was due at least in part to the January new home sales numbers, which indicated to investors that possible bad times ahead merit a more defensive portfolio posture.

Bond prices plunged today, with the benchmark 10-year Treasury reaching its highest level since early December of last year.

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The yields on Treasury securities with longer maturities point to what markets think about the economy's prospects concerning inflation and economic activity over the course of 10 or more years.

The yield on the 30-year note also rose. Today's pounding in the bond market came on renewed concerns that the Fed is unlikely to ease up in the foreseeable future on interest rate hikes after an early indicator of the month's inflation at the consumer level came above expectations. Bond market participants have been hoping that if inflation indicators remain within normal ranges, the Federal Reserve might be favorable to laying off the one-after-another rate hikes it has been executing in a record run since last year. Unfortunately, with inflation continuing to whisper all around the edges of the economy, the Fed has no choice but to keep the pressure on interest rates and the money supply, despite the risk that this aggressive anti-inflation posture will send the economy into recession some time later this year.

Had the Federal Reserve not oversupplied the economy with money to support the White House during the first four years of the Bush Administration, this situation would not have arisen. But the excess money the Fed create to finance irresponsible policy initiatives by Bush and his inexperienced, ideologically driven team have now come back to haunt the U.S. in the form of looming inflation that must now be fought fiercely and to the detriment of economic growth and prosperity.