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Economic Perception and Reality

March 27, 2017


We’ve highlighted numerous times in past missives the difference between perception and reality.  Market participants frequently perceive both as the same when they’re frequently not. 

The perception was that a new president would unilaterally incite instant change:Regulations would be swept away, income-tax rates would be slashed, health care would be reformed, infrastructure spending would ratchet higher. All this would happen, if not in a New York minute, at least as soon as the new president formed his cabinet. The reality is that change — political change in particular — comes as a glacier comes, and not as a raging river.

This reality has sunk in with many market participants. The sweeping changes that Mr. Trump proposed on the campaign trail have become less sweeping now that he’s President Trump. No one should be surprised. Political opponents obviously offer resistance. Less obvious, though always inevitable, so do many political allies. People eagerly profess they want change; they’re far less inclined to initiate it.

Reality is less inspiring than perception. This is reflected in recent financial-market activity. Investors have taken more money out of riskier assets and placed more money in less-risky assets: stocks have sold off and bond prices have risen, which has caused bond yields to fall. 

The yield on the 10-year U.S. Treasury note has settled at around 2.4%. The 10-year note influences mortgage-backed securities, which, in turn, influence mortgage rates. In less than a week, mortgage rates have dropped from a three-year high to the lowest level of March.

This suggests that stock market gains will be harder to come by.  At the same time, credit-market volatility should be reduced, which gives us more reason to believe that current interest rates should hold for some time. 

At this point, the odds that financial markets could turn negative outweigh the odds that they could turn more positive. This points to more weakness in equity prices; it could also lead to more strength in bond prices. Though the odds of it not happening are greater than those of it happening, a sub-4% quote on a prime 30-year fixed-rate mortgage isn’t beyond the realm of possibilities. 

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