It’s Fed Day. The markets are flat ahead of the read statement at about 12:15 our time. Their economic projections (AKA: “dot plot”) will be publicized, as will be the Fed Funds Rate going forward. The latter is anticipated to remain at 1.25%. Many economists are expecting the Fed to announce the implementation of the plan laid out earlier this year to sell off the better part of $4.5 trillion in assets (AKA: unwinding QE). While the markets are anticipating this flood of bonds to hit the market, it’s entirely possible that the ramifications will have hurricane-like destructive effects on interest rates, just as a real hurricane destroys the property of people, even though they know it’s coming.
Puerto Rico’s Governor told residents that their lives are in danger if they don’t evacuate. I’m telling you that if your mortgage interest rate isn’t locked in and fixed, your financial life is in jeopardy.
The Federal Open Market Committee starting up today. It will be the last for current Vice-Chair Stanley Fischer. He was a former economist at World Bank, and noted teacher at MIT, with illustrious pupils such as former Fed Chair Ben Bernanke and European Central Bank President Mario Draghi. Mr. Fischer has been a bit of an inflation hawk, warning of the risks of a prolonged low-rate environment. His vacancy opens up a fourth empty seat at the Fed for President Trump to fill.
Speaking of President Trump, he welcomes Heads of State from across the globe to New York City this week for the United Nations General Assembly. It will be a great opportunity to be Presidential and unite voices to promulgate peaceful understanding. Germany, North Korea, and Russia are all absent from the event.
Newly constructed homes represent about 10% of the housing market across the country. This morning’s reading shows a 0.8% drop in Housing Starts, but number of new Building Permits requested rose 5.7% last month.
The Consumer Price Index rose 0.4% to a year-over-year increase of 1.9%, due in part to a spike in gas prices–which are up 6.3% from January 2017. Compared to a few years back, of course, it’s still a bargain at the pump. I think that I’m paying about half of what I was to sink 20 gallons of premium into my SUV back in 2013. So you won’t hear any complaints from me right now.
In broader terms though, higher oil and gas prices lead to higher costs to produce and distribute goods, and that means inflation. Moderated inflation is what the Fed is looking for before raising rates again, but I believe that it will take more several months (and many more signs of increasing costs) before the Fed has sufficient argument to make a move of any kind.
I know that you know that this is the former Chair of the Board of Governors, Ben Bernanke, and not the current Chair, Janet Yellen. Ben Bernanke navigated the U.S. through the most difficult financial crisis in 80 years, and it is he who said “Monetary policy is 98% talk and 2% action”. That idea is a good way to introduce the Fed meeting yesterday.
The Fed raised the overnight lending rate to 1.25%, an increase of 1/4%. That will instantaneously raise the Prime Rate to 4.25%, affecting credit cards and other short-term debt instruments like car loans. It should also raise the yield on your savings account and certificates of deposit. The financial markets all expected this move and so the hike was already priced into long-term debt like mortgages, student loans, and the next iPhone.
Chair Yellen yesterday laid out a plan to begin to sell off the Fed’s $4.5 trillion dollars in long-term debt holdings. For the last eight years, they have been the world’s largest buyer of Treasury Notes and Mortgage Bonds, accumulating and then reinvesting the proceeds of sold Notes (from people cashing in Treasury Bonds or refinancing their mortgages) by purchasing new Notes/Bonds at the rate of $20-30 billion per month. That will begin to unwind once the Fed Funds Rate reaches 2.0% (presumably the first of next year). The plan is to allow $4 billion in mortgages and $6 billion in Treasuries to roll off the books every month, and to gradually increase the amount to a combined $50B/month “if the economy evolves inline with expectations”. Assuming that the hopes of the economy fulfilling the well-crafted statement come to fruition, it will take at least a decade to unravel the balance sheet in an orderly fashion.
After digesting the Fed Show yesterday, mortgage bonds took a slight breather and opened down by about 0.15 bps. Overall, interest rates are still better than they have been since last fall’s presidential election. Nationwide, the average conventional 30 year loan is at 3.91%. My rates are better than that and my service and turn times are also hard to beat!
Today is Fed Day, but because nobody thinks that the FOMC meeting will have an impact on the markets, you have to dig pretty deep in any news source to even find mention of the meeting. In the post meeting read statement, we’ll look for insight as to when they might start to sell off their $4.5 trillion in assets. That news could prove inflationary, which would lead to higher interest rates. In the last decade, inflation has been about as threatening as these two cute little ducklings.
So the Fed did in fact raise their rate 0.25% yesterday, and over the next three hours, both stocks and bonds rallied. The MBS market in fact, jumped 75bps, allowing mortgage rates to settle back into their pre-meeting groove. What gives? During her speech, Janet Yellen gave several cues (or should I say “coos”–ha ha) that indicate that the Fed may be lowering its expectations on the speed that the economy should be expanding.
The first is the observation that core inflation, excluding food and energy costs, is still under the target 2.0% growth rate that the Fed is expecting. They want the growth centered on 2.0% (allowing for readings higher or lower that 2.0%) whereas before, the target was the 2.0%-2.5% range. The second cue that all is not rose petals and puppy dogs is that the vote to hike rates yesterday was not unanimous; there were voting board members in favor of leaving rates unchanged. Still it happened, and still, Ms. Yellen is planning on three 0.25% rate hikes this year and next year.
I think that we can learn a lot by looking for patterns. For example, from working in the same office building for the last 13 years, I have noted that it’s growing nearly impossible to turn left out of my building and onto State Street between 5:00 and 5:30 PM. As a result, I either cut out early or stay late. Looking at the pattern of the 10-Year Treasury Note Yield over the last 55 years, it has traded in a clearly defined downward channel for the most recent 35 years. It’s possible that the yield continues to decline, but it’s more probable that the pattern is going to break to the upside in the next few weeks to months. Currently, that red boundary to the north lies at 2.635%. The 10 Year today is at 2.59%. The Federal Open Market Committee meets today and tomorrow, and they are expected to announce a 0.25% increase in interest rates tomorrow that will push that blue squiggly line right up next to that 35-years-and-counting straight red line. It will then only be a matter of time until it crosses the red line and, IMO, shoots straight up to 3.0%. Catching a low interest rate on a mortgage is just like catching a break in traffic: timing is everything.
Pricing on mortgages slips this morning to the lowest level since Christmas. The primary contributor to the deteriorating value seems to be the ADP Private Payrolls data, noting that 298,000 new jobs were created last month. That’s over 100,000 more positions than were expected. Employees aren’t working as hard as they have in the past, however: productivity increased by just 0.2% last quarter. That’s the smallest gain in six years. Although the official Jobs Report won’t be published until Friday, the ADP info seems to have been enough to start pushing interest rates up ahead of the Fed meeting next week. Fed Fund Futures show a 90% probability of a hike coming on the 15th.
Ordinarily I don’t go searching for online photos of posed cats. Neither do I condone violence, as a general rule. But when you have four outspoken Fed Board members giving speeches at the same time with three differing opinions about how and when to raise interest rates, it gets pretty exciting.
Bonds by nature are a conservative investment, so they are quick to raise the white surrender flag at the faintest hint of trouble. And trouble is what two of the contenders were slinging this morning. The “inflation” word was used as a cautioning omen, as well as the blanket statement that Fed has met its precursory goals ahead of normalizing rates. Chair Janet Yellen stated that the current economic conditions do support the forecasted three hikes this year. The end result for the week is that interest rates are up are their worst levels of the year…stay tuned; the fur could start flying.
It is both intriguing and discouraging how quickly our little brains forget the things that we learn and we regress to become entrenched again in our personal agendas. After last week’s congressional testimony by Janet Yellen, the perceived likelihood of rapid rate hikes these next few meetings was a virtual certainty. Throw a three-day President’s Day weekend at those trading money for a living however and that confidence wanes significantly. Today’s Fed Fund futures polls are predicting only a 17.7% probability for a March 15 rate hike, a 44.1% chance of a hike on May 3, and a 69.9% expectation for a 0.25% advance on June 14. It’s like the classic kids’ party game where the target is right in front of you, but after putting on a blindfold, you lose all sense of reality.
The fundamentals only confirm that the economy is ripe for higher interest rates. The National Association of Realtors said that existing home inventory has declined by 22% in the last six months. Lower supply=higher prices. Housing isn’t the only winner here, the S&P has gained 13.3% in the last three months. Higher prices, higher wages, and higher employment rates=inflation. And inflation=higher interest rates. Even the donkey can see that.