Mortgage rates aren’t tied to the 10yr note, they’re tied to mortgage bonds—right now most lenders use Fannie Mae 3.5% coupon to price rates—but mortgage bonds track the 10yr note medium and long term. So if Pond is right, rates would rise .375% or more. As of Friday, rates had already risen .375% over the past two weeks, then regained .125% yesterday—so we’re up .25% from record lows. So could they go more from here?

Pond’s views are outside consensus but he has a point when he says the Fed is distorting rates by pushing them lower than is justified by fundamentals. He said rates can remain distorted for awhile but ultimately money will go where it should.

So it’s a question of defining “ultimately”.

I think the forecast is extreme because the Fed will continue buying mortgage bonds, and I’ve discussed in detail how that lowers rates.

I agree that market prices for securities ultimately revert to levels driven by fundamentals, the Fed plus Eurozone debt crisis and U.S. fiscal policy paralysis will outweigh fundamentals near-term.

Because of this, I think rates remain in their current range +/- .25% by year end.

-No Rise In Home Prices Until 2020 (CNBC)
-Housing Still U.S. Economy’s Albatross (WSJ)
-ECRI: Recession Is Inescapable (TheBigPicture)
-What Charts Tell Us About Next 90 Days (UpsideTrader)
-Gundlach On Bond/Rate Market Outlook (PragCap via Josh Brown)

When we measure GDP we always adjust it for inflation.  We want the economy to be growing because more good and services are purchased by comsumers, companies and the government not because the cost of those increased.  The dollars spent pre-inflation adjustment are called “nominal dollars.”  The inflation adjusted ones are called “actual dollars.”

What Rick is doing here is using the BLS CPI-U deflater for the consumer portion of GDP and the PPI deflater for the government and investment portion of GDP to get from nominal dollars to actual dollars.

BEA’s GDP data is suspect and it makes no sense to make important fiscal and monetary decisions based on bad data provided by a government agency. Like myself, Rick has a degree in physics and I understand his belief that we need good data to make good determinations. Rick had for about a year and a half wondered why BEA data showed a much rosier picture than his data. We may be discovering that Rick’s data was more objective. The rest of this post is written by Rick.

HAS A DOUBLE DIP RECESSION ALREADY HAPPENED?
by Rick Davis, Consumer Metrics Institute

During the past several quarters we have been persistently critical of the “deflaters” that the Bureau of Economic Analysis (BEA) has used to convert their “nominal” current dollars) GDP data into inflation-adjusted “real” (chained 2005 dollars) data. Quite apart from our concerns about the accuracy and delays in their “nominal” data, we have often found their “deflaters” lacking credibility — and in some cases egregiously so. And recently we have suggested that the entire reported annualized growth rates were merely artifacts of overly optimistic understatements of the actual inflation rates in the US. Furthermore, major portions of the BEA’s recent massive downgrades to historical GDP growth rates were the result of restating historical “deflaters” to levels more consistent with the inflation data previously recorded by their sister agencies, constituting a tacit admission of their past tendencies to just such understatements of historical inflation.

Over the past weekend Mike Shedlock (“Mish”) asked us to put those assertions into some more substantial form.

Meanwhile Doug Short has also been tracking this phenomenon, and he has been charting the BEA data using several different alternate “deflaters” in his commentary.

The logic of “deflaters” is simple: as you might expect the BEA can only capture production and consumption data in current (“nominal”) dollars, which are distorted over time by the impact of price inflation. To offset that distortion the BEA uses a set of price-indexes to “deflate” the “nominal” GDP into a “real” GDP that is then reported in “chained 2005 dollars” (i.e., all distortions caused by price changes since 2005 are in theory removed from the data before the “real” economic growth is reported).

The Tables
The BEA goes to great lengths to report the data both ways, and provides detailed spreadsheets that can be downloaded by the curious: the “nominal” data can be downloaded in Table 1.5.5 and the “real” (inflation-adjusted) data can be found in Table 1.5.6. Note that although each column in the tables represents a different quarter, the numbers in those columns are “annualized” (i.e., 4 times the actual quarterly tallies). Similarly the growth rates reported by the BEA in Table 1.5.2 are “annualized” (i.e., the quarter-to-quarter rates of change are projected out for a full year).

By using the information in the the BEA’s tables it is relatively simple to “reverse-engineer” the actual “deflaters” that they have used to convert from their “nominal” numbers to their purported “real” numbers. The following table shows the BEA’s reported “nominal” and “real” annualized GDP for the past 10 quarters, along with the reported “real” growth rate and the “deflater” used by the BEA to convert from the “nominal” to the “real” numbers (most recent quarter on the left):

BEA’s Quarterly GDP Past 10 Quarters

The Problem
Focusing for the moment on the bottom line in the above table, the BEA’s “deflaters” tell us that they believe that inflation over the prior two quarters has been running at annualized rates of 2.51% and 2.72% respectively—and the annualized inflation rate for the prior four quarters was just barely over 2%.

Think about that for a moment. Is it remotely plausible that the 12 months ending this past June saw net inflation just barely over 2%?

Even if they have accurately captured the “nominal” data for those two quarters (which requires a major leap of faith in its own right), the “real” numbers should strain credibility every bit as much as the purported inflation rates.

However, the BEA is not the U.S. Federal Government’s primary source for inflation data. That honor falls to the Bureau of Labor Statistics (BLS) within the United State Department of Labor. If we presume for the moment that the BLS’s reading of inflation rates is at least as authoritative for “deflaters” as the BEA, we can piece together credible alternative GDP growth rates using the “nominal” data from the BEA and calculate the “real” data using “deflaters” derived from the BLS’s unadjusted CPI-U (CUUR0000SA0) consumer price index table and their unadjusted PPI (WPUSOP3000) producer price index table.

When we recast the GDP growth rates using the BLS sourced deflaters we can build the following table showing the past 10 quarters of growth in “nominal” GDP, “real” GDP using the CPI or PPI tables (as appropriate for each individual GDP line item), the per-capita “real” GDP similarly calculated and the per-capita “real” disposable income (again most recent quarter on the left):

Annualized GDP Growth Rates Past 10 Quarters

The Charts
Charting the past four years of GDP data shows some glaring differences between the BEA’s official version of U.S. economic growth and BLS price index “deflated” versions of the same “nominal” data. First the BEA’s official version of annualized “real” GDP growth rates:

Now compare that official growth rate with the annualized growth rates derived using the BLS CPI-U or PPI (as appropriate for the parts of the economy being measured):

A glance at the above chart reveals several startling changes from the “official” version of U.S. economic growth. At least two alternative readings of economy history can be pulled from the graph:

-First and foremost, on the right hand end of the chart the past two quarters have been in contraction — meeting the clinical definition of a new recession.

According to this chart the second dip has already happened.

-On a more academic note, in the left half of the chart the shape of the first “dip” is now shown to be substantially different than we had been led to believe but perhaps not all that different from what “Main Street” consumers sensed at the time.

Just as increasing prices can stifle economic growth, decreasing commodity prices can stimulate demand for discretionary goods. The rebound in consumer demand that we witnessed here at the Consumer Metrics Institute at the end of the fourth quarter of 2008 was the consequence of rapidly deflating energy prices—and the highly prominent upward one-quarter “blip” in the recalculated “real” GDP is a sign (or perhaps an artifact) of the 2008 crash in gas prices.

Consumers clearly felt the change in purchasing power that is visible in this chart and responded in ways that were captured in our nearly real-time indexes. All of this began to happen a full quarter before the financial markets bottomed in early March 2009. That surge of economic activity, however, was completely missed by the BEA because of the inertia in their deflaters.

The 4Q-2008 upward “blip” was very short-lived and the subsequent contraction was much longer than the “official” record would indicate.

Is the 4Q-2008 upward “blip” the trigger for the subsequent recovery or an anomaly in the data? The best answer is probably both. The surge was a transient effect of lowering energy prices that could not by itself sustain the entire economy. But it provided those consumers who still had steady jobs a significant increase in disposable discretionary funds, which they used to then create surprisingly good holiday sales. It at least confirms one of our themes here:

the “Great Recession” was more complex than generally credited and evolved dynamically at the consumer level in ways that the BEA simply failed to notice.

The Bad News
The bad news is that all of the recalculated GDP growth rates show a 1Q-2011 that is far more abysmal than is commonly recognized. But we suspect that the consumers that we track knew this all along: their demand for discretionary durable goods plummeted during that time span and bottomed in late May. The good news, however, is that the last quarter shown in the three charts immediately above shows moderation in the contraction rate—again consistent with what we are now seeing in our indexes, given a one to three month lag in consumer response times.

Our bottom line is that the “real” economy has been worse than previously reported, and the full impact of that lethargy has yet to be felt at the factory level. But the good news is that deflating commodity prices (e.g.,gasoline) can have a remarkable and sudden impact on the economy. Let’s hope that ongoing relief at the gas pump will soon spread to the rest of the economy.

Nearly all ‘record low’ rate headlines hit Thursdays. That’s the day Freddie Mac releases its weekly rate survey covering the previous week. The survey is source material for nearly all media, but the rates aren’t relevant for all homes nor borrowers.

Rate Headlines vs. Reality
Headline rates are expired by the time you’re reading about them, and here’s some other fine print most media stories don’t catch: those rates are only for loans to $417k, single family homes only, owner-occupied only, and those loans have .7% to .8% in points (aka extra fees) on top of a full set of closing costs.

So if you bought a condo with 20% down earlier this year and you’re looking for a zero-cost refinance of your $475k loan, your rate quote as of Friday was about .48% higher than the headlines you were reading. Here’s the fine print.

Rates change throughout each day as mortgage bonds trade, and a rate quote is based on your profile and your property profile, so it must come from a lender to be specific.

Double-Dip Fears Fuel Low Rates
Last week’s U.S. economic data fueled double-dip recession worries. Fed manufacturing reports (1, 2) confirmed a three-month slowing trend, existing home sales posted an eight month low, and jobless claims again broke above 400k after just one week of improvement.

Business and consumer inflation (PPI and CPI) were both a bit hotter, but not enough for alarm bells, especially when lower inflation readings from the manufacturing surveys suggest PPI will moderate.

Rate Preview August 22-26
Weak data suggest rates shouldn’t spike next week, but the “here and gone” rate lows will continue as mortgage bonds battle tough price ceilings. Rates drop when bond prices rise, and every time mortgage bond prices touch highs in the past two weeks, they quickly retreat, sending rates higher.

To manage this volatility, you need to set a rate target you can’t or won’t go below, then watch the market to see if it goes lower. BUT you should give your lender a standing order to lock that rate if it’s ticking up—which happens in minutes, not days.

Here’s a case for why rates might go even lower next week, but this is rooted primarily in Treasury trading, not mortgages. So the safe bet is the standing lock order recommendation above.

Economic calendar highlights next week include July New Home Sales Tuesday, FHFA home prices Wednesday, jobless claims Thursday, and the second of three 2Q2011 GDP readings Friday. The first reading was an anemic 1.3%.

We also have $99b in Treasury auctions as follows: $35b 2yr Notes Tuesday, $35b 5yr Notes Wednesday, $29b 7yr Notes Thursday.

Stay tuned daily on Twitter and Facebook.

Follow @thebasispoint

This might send mortgages to record low rates as long as MBS track Treasuries. This is not simply about the U.S. economy. It extends to Europe and Japan as well.

(1) Nation Declined. Which has a double meaning of course. Credit to my wife for this one.

(2) “It’s not a recession, it’s a correction. Correction: it’s a recession.”
-Stephen Colbert 4/3/2008

(3) “Shit. I know shit’s bad right now. With all that starving bullshit. And the dust storms. And we running out of french fries and burrito coverings…”
-President Camacho’s state of the union speech opening lines from in Mike Judge’s masterpiece Idiocracy. Video of full speech embedded below.

-3 New Names For The Great Recession (Weakonomics)
-Great Recession: Time For A Name Change (HuffingtonPost)

To start, I want to make clear that it has always been my belief that there is little that the President and Congress can do to create jobs. When we have recession we have an excuse for the party not in power to diss the party in power. Reagan did this to Carter and Clinton did this to George H. Bush. But none of these guys create jobs. Jobs are created by a coming together of capital and labor to provide a product or service which people want. The main thing that government can do to help create private jobs is nothing. I do not say that to be glib. I sincerely mean that government regulation and government policies hurt more than they help.

So what is wrong with the jobs market? The answer is: a lot.

I think that the most important thing to recognize is that part of the reason why economic recovery has been so dismal is that this past recession was not simply a cyclic recession which could be addressed by Keynesian deficit spending. The big issues in the jobs market are structural not cyclic.

The Bureau of Labor Statistics recognizes that the goods producing jobs consists of 4 supersectors: Natural Resources and Mining, Mining, Quarrying, and Oil and Gas Extraction, Construction and Manufacturing.

The Manufacturing sector comprises establishments engaged in the mechanical, physical, or chemical transformation of materials, substances, or components into new products.

Manufacturing jobs have been offshored. This is a consequence, in large part, of the enormous differences in wages between China and the U.S. The average manufacturing job in China pays about 75 cents an hour. (This data is not well publicized by China but that 75 cents is a best guess.) According to this BLS report the average hourly earnings of production and nonsupervisory employees on goods producing Nonfarm jobs was $20.62 last month. I think that unless the Pacific Ocean dries up we are not going to recover a significant number of manufacturing jobs from China.

The fact that these manufacturing jobs have disappeared is a structural change not a cyclical one. The manufacturing of almost everything has moved offshore: clothing, computers, consumer electronics, appliances, machine tools etc. We are not losing manufacturing jobs because our factories are inefficient or make things no one wants. We are losing the jobs which manufacture the stuff we all want and we are also losing our dominance in high tech. That wonderful thing called the iPad may have been designed in California but it is manufactured in China. In 2008 there were 1.2 billion cell phones sold in the world. Zero of those were manufactured in the USA. The US has lost its dominance in printed circuit and semiconductor manufacturing.

The Chinese economy has flourished only because it was able to take that which already existed and use its enormous stock of low paid workers to make stuff cheaper. China has no inside track apart from that. China is to manufacturing what Wal-Mart is to retailing.

One conclusion is the the U.S. economy is in a hopeless state regarding jobs. Another possibility is that we are experiencing a case of Schumpeterian Creative Destruction. In fact this could be the Mother of All Creative Destructions.

What Am I Talking About?

In his book “Capitalism, Socialism and Democracy”, Joseph A. Schumpeter wrote, “The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.” Schumpeter saw capitalism as surviving by not merely innovating but by mutating and destroying the old economy in order to make room for the new economy.

I believe that the only manner in which we will see significant changes to our economy and the quality of our lives is through new and visionary technologies.

Consider some fairly new companies: Google and Facebook. What do they manufacture? Absolutely nothing physical. I am by no means minimizing the difficulty of creating and maintaining these massive entities. I am only observing that their product is not physical.

The Internet has created companies such as Zynga (the creator of Farmville) which provides on-line games for free and sells virtual products to enhance play. Many iPad games use this business model – give someone a game for free and then sell them virtual stuff for real money. The worldwide market for virtual good last year was about $9.28 billion. That is not a large number. My point is that people pay a lot of money for things which are not physical objects: cell phone service, cable TV, WSJ on-line, iTunes and that is being extended to objects in virtual worlds such as Farmville.

Intellectual property (books and music) is becoming digital. Books, vinyl records and music CDs are following the 8-track tape down the existential path to non-being.

Apple holds a big hand for this with iTunes. Netflix is moving from an entity which sends DVDs in the mail to and entity which provides streaming content via the Internet. I can watch “Alfred Hitchcock Presents”, “Have Gun Will Travel” and “Twilight Zone” delivered by Netflix on my BluRay player and recall the “good old days of TV.”

Technology is also capable of creating things which are far from virtual. This is about a company which creates perfect fitting 3D bikinis. Perhaps in the near future young women can go into stores and buy a perfect-fitting pair of jeans which are “printed” on the spot. Same for shoes. 3D printing can also used to create objects such as dental bridges and implants. RepRap is a low cost 3D printer (you can build it yourself) which is capable of self-replication. It can print another copy of itself.

3D printing could have medical applications. We may be able to create body parts on demand. See this article from the Economist, or this piece from Physorg.com. This could eliminate the need for organ transplant donors. Athletes with bad knee, elbow, or shoulder injuries could have those parts replaced. Burn victims could get new skin quickly. Today a patient in Sweden is being discharged after his cancerous windpipe was removed and replaced by the world’s first artificial trachea, made of his own stem cells grown on a man-made plastic matrix.

The post-Singulatity economy may see economic value existing largely as intellectual property. I could design clothing and deliver it to my customers by 3D printing: no factories, no junior sportswear shops in malls – just a bunch of teen-age girls using their smart phones to get their jeans out of a row of ATM-like machines. The new line will be, “That is so, like 12 hours old. Look what just came out 4 minutes ago.”

This has already happened with nonphysical things such as music, books and newspapers.

It may be the case that we are about to see something which has an enormous impact on society and the economy. It could be the case that we are approaching a time when both goods and services are largely delivered by computers or created by 3D printers connected to computers. Wealth would take the form of the ownership of the 1′s and 0′s that described how to make something and fewer people may have to work. I am not implying that you would have a printer in your home that would make anything. You might simply order a bunch of clothing or some tools and hardware by computer, pay for it by credit card and drive to the mall to get it. There would be no inventory, no transportation costs and little cost associated with retail markup. Heck there would be no shoplifting.

I don’t not believe that this would be a smooth transition. When we had the Internet boom on the 1990′s we had a very low unemployment rate because so much speculative capital was deployed. Much of that boom was actually a bubble. The next tech boom may well produce another economic bubble of equity prices and jobs but could end in a very serious drop in employment.

Perhaps we should be thinking of an economic order in which fewer people have to work while everyone gets the basic necessities of life inexpensively. In reality this is as much a philosophical shift as an economic one. In future election cycles we might hear a candidate say, “Vote for me and I guarantee that 4 years from now 10,000,000 of you will no longer have to work.”

(1) Reconsider our participation in the Basel accords and recognize that purely commercial banks have a different set of risks that the now hybridized investment/commercial banks. These regulations penalize purely commercial banks by demanding higher capitalization while insanely suggesting that derivative trading is no more risky. The people framing Basel III are considering something like this. As I wrote recently the “one size fits all” notions of Basel are counterintuitive. I see no reason why every country needs the same rules. The biggest problem I have with Basel is that it assumes that risk is static.

(2) Enact Simpson-Bowles. Absent a comprehensive solution for fiscal sustainability, nothing else matters.

(3) Encourage privatization of infrastructure spending.

(4) Eliminate some government regulations which discourages infrastructure building and job creation. The notion that Keynesian deficit spending can jump start the economy may have been rendered useless by excessive regulation regarding environmental protection and zoning

(5) Give a new agency control over the deficit

(6) Recognize that politics is the problem not the solution.

(7) Eliminate government agencies which are no longer needed or have failed.

(8) Discourage the government from creating asset bubbles (see next paragraph.)

Each of those is a short phrase but a massive change in the way of doing things. What we must recognize is that the problem is not an economic one but a political one.

Simpson-Bowles is the best example. Presented with a comprehensive solution to our fiscal ills, the President and most of Congress have ignored it because it is not compatible with reelection.

Another example is Dodd-Frank. Congress gave no recognition to the fact that the subprime mortgage mess was set into motion by the government with the 1994 National Homeownership Strategy.

Politicians have placed the blame on banks (let me be clear that banks certainly played a gigantic role in this) and passed Dodd-Frank which creates more banking regulation.

It will be years before the effects of Dodd-Frank on the banking system and the economy in general are felt.