I’m going to geek out for a minute this morning, so you can delete this email right now if you’re not in the mood. This commentary grew much longer than I had anticipated. :).
Yesterday, the Institute of Supply Management (ISM) Non-Manufacturing Index was released showing that orders of parts used in the manufacturing of other goods and services rose 2.1 points from last month and 3.2 points greater than expectations suggested. With only a handful of reports due prior to next week’s Fed meeting, each will be closely watched as in indicator of what the FOMC will do with the Fed Funds Rate next Wednesday. The major consensus is for a 1/2% rate hike (50bps) to be announced at the close of the conference. You knew that already.
Now for the interesting part. The long term rates seem to be caring less and less about headline inflation and what the Fed’s doing and more and more about the likelihood of recession next year. Global financial firm UBS predicts a 70% chance of a U.S. recession in 2023 with the Unemployment Rate rising from 3.7% to 5.5% (which is not horrible at all). Incidentally, once this happens, the Fed will start the slashing cycle again. Such is the existence of a reactive Central Bank. This is not a dig on them; their job is to engineer employment and price stability, not micromanage every nuance of the dollar.
Now for the writing on the wall. But first let me set the stage. As an implication of convenience and risk, the longer you commit your money to someone, the higher your return will be. Conversely, the longer you take to repay debt, the higher will be your imputed interest rate. Let’s say you give the federal government some of your hard-earned after-tax dollars that you’ve scrimped and saved over a lifetime of diligent efforts. You would expect that if your money was tied up in the hands of bureaucrats for a decade, they’d reward you greater than if you only gave them free rein with your money for 24 months. Now let me be clear that it’s the free market and not the government that sets the going rate of treasury bills. The more money that gets thrown at a particular investment, the less that fund needs to pay to keep people interested. Right now, you get a better return on a 2 year Note than on a 10 year note. In fact, you get a better return on every t-bill other than the 10 year note, starting with the 1 month bond and heading all the way to a 30 year commitment.
The 2/10 Spread is currently at a whopping -82bps with the 2 Year paying 4.39% and the 10 Year paying only 3.57%. The historical recessionary implications of such a large discrepancy are virtually unanimous, and the spread hasn’t been so large since 1981. Each of the gray bars in the chart below indicate a recession and always follow a negative 2/10 spread like we have right now. Those optimists who say we will avert a slowdown are just looking for more airtime, or are blinded by their rose-colored naïveté.
Having said that, I am an optimist! Absolutely! But I am also a realist and seek only to be prepared for what is most certainly coming our way. Ignorance can be bliss, but only until the cards don’t fall your way. So yes, I am expecting inflation to fall and with it will slow the velocity of money and business activity. I don’t know what that will look like nor how ling it will last. I study trends and see that all numbers eventually reverting to the mean. The sooner we get into it, the quicker we’ll be out of it.
Speaking of means, and charts and stuff. That top chart shows the prices of mortgages as they get traded every day. Green days are good and red days are bad if you like low rates. High prices mean low rates and vice versa. Rates have trended higher all year long until November 10th when pricing shot up almost 200 bps and drove interest rates down 1/2% in one day. The course has been relatively flat, but pricing is trending higher since then.
Now for the technical-geeky part. If you look at the 20/50 day moving averages which I have also illustrated as green and red lines, you’ll see that there was a crossover on November 23, indicating that there are lower interest rates ahead. I don’t know for certain how soon mortgage pricing will improve nor for how long it will last. But, if the macroeconomic trends deteriorate like the FOMC is strategizing to effectuate, we’re in for lower interest rates in the future. For sure.