Headwinds And Unsustainable Trends

October 20, 2023

This past week home loan rates touched the highest levels in this century. Let's talk about the recent headwinds for interest rates and other big events as we march toward the next Fed meeting on November 1st.

Headwind #1 - QT

Back in 2020, to stabilize the U.S. bond markets, the Federal Reserve began a process called quantitative easing (QE). This involved the Federal Reserve purchasing Treasuries and mortgage-backed securities and adding them as assets on their balance sheet. This process helped stabilize the bond market during the pandemic and lowered rates beneath 3.00%.

Today, to fight inflation and slow demand, the Federal Reserve is doing the opposite, in a process called quantitative tightening (QT) or balance sheet reduction. This is where the Fed allows matured Treasuries and refinanced mortgage bonds to roll off their balance sheet. This process has put upward pressure on long-term rates, with 30-yr Fixed rates hitting 8.00% this week.

In the absence of the Federal Reserve stopping or slowing the quantitative tightening process, we should expect the trend of higher interest rates to continue.

Headwind #2 – Debt

The U.S. has amassed a record $33T in debt with no signs of the deficit spending coming to end. This means our government will have to issue more Treasuries to collect the money needed to run the country. Every couple of weeks, the Treasury sells these bonds, however the buying appetite has been weak, so the Treasury Department has to pay more yield to attract the buyers.

Headwind #3 China And Japan Are Sellers

Japan and China are the largest foreign countries in the world holding U.S. debt, with close to $1.5T between them. Both countries have been sellers of our bonds as opposed to purchasers of our debt. Why? Inflation. The U.S. dollar has been strengthening mightily throughout the year, causing foreign currencies to decline in value and making commodities and imports more expensive. China and Japan have been selling some of their vast holdings while using the proceeds to purchase their own currencies to limit the effects of inflation.

Headwind #4 Short Sellers Betting On Higher Rates

In the financial markets, one can bet on prices going up or prices going down. Short-sellers or people who are betting on Treasury prices, and mortgage bond prices going down and rates going up realize that the Federal Reserve is shrinking their balance sheet, growing our debt while Asia and other countries around the globe are selling U.S. debt. This short selling is adding to the volatility and sharp move higher in rates.

These are just four of the headwinds long-term bonds are facing now, as there are more. How does this trend of spiking long-term rates end? One way to quickly stop this rise, is for the Federal Reserve to announce a slowing or outright stopping of quantitative tightening or balance sheet reduction. This would put a buyer in the market, push back the sellers and take pressure off Asia to sell their U.S. bonds. This is not currently in the cards but is a story that could change very quickly.

Housing, which is interest rate sensitive, and a main driver for the economy has slowed significantly with mortgage applications at the lowest levels since 1995. There is a moment coming where the Federal Reserve may be forced to pivot and change direction as the current trend is unsustainable.

Bottom line: Home loan rates have hit the highest level of this century with housing activity slowing and leaders in mortgage and housing sounding the alarm for help…each day is closer to a shift in policy.

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