Stocks Whipsaw Down Wednesday, Up Thursday Morning
In early trading Thursday, stocks made a strong recovery, at least to some extent on bargain-hunting after the fire-sale discounting equity issues have suffered over the past week, but also on news of a drop in jobless claims. The downside of this surge back to stocks is that bond prices are plummeting this morning, thus renewing the long-term upward trend in yields. By mid-morning, however, the major indices had given up some of the heavy gains achieved in the first hour.
Confirming the effect of the inexorable rise in interest rates across the economy, the Mortgage Bankers Association on Wednesday reported that its index of mortgage applications fell by more than one-and-a-half percent last week, turning against an uptick in the week previous. This was somewhat surprising to some because mortgage interest rates had actually eased back a bit.
However, the mortgage market is driven by factors other than interest rates only. In particular, the decision to take on a first or second mortgage has much to do with prospective borrowers' expectations about their personal financial situations in the months and years ahead. In an economic environment where households have serious concerns that are more than mere passing worries, decisions on major, new debt committments get postponed or abandoned altogether.
Dark Wraith CyberGlossEconomists and financial analysts hold that what has already happened is, at least in principle, much less important than the expectations of consumers and businesses about the future.
As far as the March consumer price index released on Wednesday, both the overall and the "core" rates were above those for February, leading many investors and analysts to see more evidence of mounting inflationary pressures in the economy. Of more immediate concern than the long-term, corrosive effects of such inflation is how the Federal Reserve will react to it.
While few believe that the Fed will stop raising short-term interest rates in its fight against inflation, the hope was that the central bank would continue its recent pattern of "measured," quarter-point increases in the key federal funds rate. Wednesday's evidence that inflation is picking up momentum led to some worries on Wall Street that the Federal Reserve might have to take its gloves off and become more aggressive in future rate increases. Investors' assessments of the probability, small as it might be, of that scenario caused much of Wednesday's downdraft in stock prices. Easing concerns about that possibility on Thursday morning allowed a somewhat more positive valuation regime to take over, at least for a while, on the Street.
Dark Wraith CyberGlossSecurities prices are inversely related to interest rates. Whether it be stocks or bonds, when interest rates go up, the prices of the stocks and bonds go down. More importantly, when interest rates are expected to go up, securities prices fall.
Regardless, however, of whether the Federal Reserve Board chooses to fight inflation with large or modest increases in short-term interest rates, the trend is decidedly upward for factors that go beyond the decision making of the Federal Open Market Committee. With continuing demand pressure on capital markets caused by federal budget deficits that cannot seem to be controlled, the U.S. government will continue to compete for limited lendable funds and bid interest rates up to whatever extent is necessary to secure its financing needs. Until such time as fiscal prudence in both expenditures and tax policy return to Washington, then, interest rates will labor under upward pressures; and as such, the U.S. economy will suffer from the debilitating effects of those interest rates.