This past week, we watched mortgage-backed securities (MBSs) make 2021 price lows, which means the highest home loan rates in 2021. Let’s talk about three things moving the markets and what to look for in the week ahead.
1. Consumer Sentiment Remains Near a Decade Low
The Michigan Consumer Sentiment for October was reported at 67.4, hovering near a decade low. The reason? Inflation. Even though we are seeing the highest hourly wage gains in decades, they are being completely outpaced by the rise in prices, which means we are currently seeing negative wage growth, where wages do not keep up with price growth.
This is not a good thing in the longer term. If inflation does not moderate as the Fed had been expecting, this will put pressure on the consumer. If the consumer slows spending due to lack of purchasing power, our Gross Domestic Product (GDP) will decline, as consumer spending makes up two-thirds of our economic growth. We do not want to see consumer spending stall or stop, or we will be seeing bits of stagflation – high inflation and slow growth.
For now, the consumer remains resilient with the ability and willingness to spend. What happens next from a policy response (WH Administration and Federal Reserve) will be very important in 2022. The wrong move at the wrong time could have lingering effects on our economy.
2. MBS Make Fresh 2021 Price Lows
It is important to know that MBSs determine home loan rates, not the 10-yr Note. So even though the 10-yr yield, at 1.67%, has not made a new 2021 high yet, home loan rates hit their highest levels of 2021.
If MBS prices fall much beneath current levels, we are likely to see prices fall further and rates heading higher towards pre-pandemic levels.
This should not be a surprise as the Fed, which we mention above, helped the economy with its pandemic-induced bond-buying program. That bond-buying program is now being tapered and it is scheduled to end in the middle of 2022. Less bond-buying should lead to a gradual increase in home loan rates over time. If you add on the persistently high inflation, one could argue that rates should probably already be higher than present levels.
3. Fed Chair Powell Renominated
President Biden announced he was going to renominate current Fed Chair Jerome Powell to another 4-yr team. He cited his experience and steady hand through the depths of the pandemic. As it relates to housing and mortgage, the Federal Reserve was a savior.
Back in March of 2020, the Fed immediately started a bond-buying program to help stabilize the disrupted MBS market and to pin down long-term mortgage rates. It worked. The Fed’s action created a boom of refinancing and purchase activity which helped grow the economy at a time when many industries were shut down or struggling.
In response to the nomination, the financial markets started pricing in Fed rate hikes as Jerome Powell is less dovish or tolerant of inflation than the other person up for nomination, Lael Brainard.
Stocks were under selling pressure all week in response to the spike in rates, threat of inflation, and increased likelihood of rate hikes.
It remains to be seen when and if the Fed will be able to hike rates sometime in 2022. We have already heard from countries abroad, like the European Union, who recently said they are not likely to hike rates until 2024…citing another wave of Covid and restrictions that will disrupt economic activity.
Bottom line: The Fed is tapering, and inflation is running high, well north of mortgage rates. This is unsustainable over the long term. Either inflation comes down, rates go up, or a bit of both. This means if you are considering a mortgage, take advantage of pandemic-induced rates, while they exist.
This past week, we watched mortgage-backed securities (MBSs), drift down near the lowest prices of 2021, which means the highest home loan rates in 2021. Let’s talk about three things moving the markets and what to look for in the week ahead.
1. Let the Taper Begin
The Fed officially started tapering or scaling back their bond purchases this week. On average, the Fed will be buying about $4.8B per day over the next month, down from $5.3B.
The plan is to “taper” by $5B per month every month and remove the additional $40B in MBS purchases every month. Note, even when the Fed is done tapering, they will still be buying MBSs daily as billions of dollars are reinvested from the principal being returned on refinancing and purchase activity.
With all things equal, once the Fed removes this pandemic-induced MBS buying, it is reasonable to think home loan rates should drift higher towards pre-pandemic levels as well.
Over the next few months, as the Fed tapers, the outlook for inflation, employment, and what the Fed does next with rates will also have a role in the next directional move in rates.
2. Benefits of a Strong Buck
The bond market has been showing amazing resilience despite the Fed taper and hot inflation. One reason is the strong U.S. dollar. The buck has been rallying for weeks as our country outperforms those around the world and our yields are “juicy” when compared to negative yields around the globe. Additionally, the Fed tapering and threat of a rate hike in the summer of 2022 is also helping the greenback strengthen.
The benefits of a strong U.S. dollar are as follows:
- It makes our imports less expensive or disinflationary. It helps keep commodity and oil prices (those priced in dollars) in check and it makes our debt/bonds more attractive to global investors.
- With the Dollar at a 16-month high, it is now touching a resistance level, which could pause or even push the dollar lower. The Build Back Better Framework, which is being debated in D.C., could also influence the dollar. More spending could lead to dollar weakness, no more or little spending could lead to dollar strength.
- If the greenback continues higher, it is good for bond/rates, inflation, and Fed policy (maybe hold off on rate hikes). The opposite is true.
3. Consumers Paying More, for Now
Inflation expectations are simply the rate at which consumers, businesses, and investors expect prices to rise in the future. This means inflation is self-fulfilling, if people believe or “expect” higher prices, prices will go higher.
This past week we saw a very strong Retail Sales number, which highlighted that the consumer has an ability and willingness to spend. Consumer spending makes up two-thirds of U.S. economic growth, so it is important the consumer doesn’t retreat.
What can hurt the consumer? Inflation and the decline in purchasing power. That is starting to rear its ugly head. Retail Sales and other reports of late like the Empire Manufacturing Index showed the “prices paid” by consumers and producers are soaring. Sometime in 2022, we will see if the inflation is transitory and recedes, or it increases. If the latter takes place, consumer demand may be challenged, which could lead to slower economic growth.
Bottom line: The Fed is tapering, and inflation is running high, well north of mortgage rates. This is unsustainable over the long term. Either inflation comes down, rates go up, or a bit of both.
Last Week in Review: Fundamentals and Technicals Collide
This past week, we watched mortgage-backed securities (MBSs) touch their highest level since late September, meaning the lowest home loan rates. But the good vibes and rate improvement were quickly halted as prices hit key technical barriers. Let’s break down what happened.
1. Global Yields Decline
The bond market is global. Meaning there are investors all over the planet in search of yield. So, when these investors look around the globe and see negative-yielding rates throughout many bond markets, it makes our anemic 10-yr Note yield, presently at 1.48%, look attractive. Our low, but outperforming yield, will always attract capital from around the globe and is a major reason why we haven’t seen or likely will see a material increase in rates.
This past week rates around the globe moved lower, which pulled our 10-yr Note lower, which in turn helps MBS prices move higher and home loan rates lower. In Germany, their 10-yr Bund moved from – 0.10% to – 0.30% on the notion the European Central Bank will not be hiking rates anytime soon.
There is about a 165bp spread between the German Bund and our 10yr Note which at times narrows and widens but is a reliable figure over the long term. So, when there are problems in Europe and the Bund declines, we often see a similar decline in our yields. The opposite is true.
2. High Inflation Persists, Bonds Don’t Care…for now
Inflation is the archenemy of bonds, or so we are taught in economics. Generally, as inflation rises, interest rates must rise to compensate investors for the additional cost of inflation. Today, investors are not being compensated for the negative effects of inflation when purchasing a long-term bond like the 10-yr Note.
The Consumer Price Index (CPI) was delivered on Wednesday. It showed overall consumer prices, which included energy and food, were up a whopping 6.2% year over year, the fastest pace in 31 years.
Inflation this high makes the 10-yr Note, yielding 1.48%, a horrible investment. Who would buy such a bad investment? For one, foreign investors, who are familiar with negative yields. Our Federal Reserve is also a big buyer of our Treasuries every month.
There is a big debate whether high inflation will be transitory. One thing to watch closely is whether inflation expectations are rising. If inflation expectations rise, meaning – if people think or feel prices will rise, they will.
Right now, inflation expectations for the next 10 years are running at 2.63%, the highest in decades. If this number goes higher, it will put pressure on the Fed to speed up their bond tapering program and ultimately hike rates.
3. Technicals Matter
After a sharp decline in rates over the past couple of weeks, many ask, where is the bottom? This is where technicals can be incredibly important. The 10yr Note and the German 10-yr Bund rate decline stopped right at its 200-day Moving Average.
For rates to move beneath this important moving average, it may take bad news which bonds like. At the moment, with inflation rising to the highest level in 31 years, it may be difficult for rates to improve much, if at all from here.
Bottom line: Home loan rates have made a marked improvement over the past couple of weeks. But tough technical levels and another hot inflation reading may limit further rate improvement.
Last Week in Review: Fed Tapers, No Tantrum
This past week, the highly anticipated Fed Meeting took place. As expected, the Fed announced it will taper bond purchases starting later this month. The good news? Bonds and stocks didn’t have a tantrum. Let’s break down what happened and what to look for in the weeks ahead.
“In light of the substantial further progress the economy has made toward the Committee’s goals since last December, the Committee decided to begin reducing the monthly pace of its net asset purchases” FOMC Statement – Nov 3rd, 2021.
Fed Chair Jerome Powell held a press conference 30 minutes after issuing the Fed Monetary Policy Statement to provide further color on the Fed’s outlook and to take questions.
The Fed has been very clear that they want to finish tapering bond purchases by the middle of next year. They’ve also shared that there will be no rate hikes until they are finished tapering.
“The Committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook” FOMC Statement – Nov 3rd, 2021.
The “but” and idea that they are prepared to adjust purchases means that if inflation or inflation expectations rise further, the Fed may very well accelerate the tapering, thereby finishing bond-buying sooner and opening the door to rate hikes sooner. The opposite is true so, if we underperform or inflation moderates sooner, the Fed could taper more slowly, thereby pushing rate hikes out further.
“We don’t think it is time to raise rates” Fed Chair Jerome Powell – Nov 3, 2021, Fed Press Conference.
“We continue to articulate a different and more stringent test for the economic conditions that would need to be met before raising the federal funds rate”
This more “stringent” test means we need to see maximum employment. In the last 12 months, the Fed has redefined what “maximum employment” means, and they reiterated that this week.
The Fed wants to see maximum employment “broad-based and inclusive”, meaning they want to see Hispanic, Black, and Asian unemployment come down much further. They also just added they want to see maximum “participation” – meaning they want to see the size of our labor pool increase…it is currently at a 45-yr low. Until these metrics meaningfully improve, the Fed is not likely going to hike rates.
Presently, the financial markets are pricing in a high probability of three rate hikes in 2022. For the Fed to hike rates three times next year, the Fed will have to be finished with tapering and we will need to see enormous labor market improvement…time will tell.
Bottom line: Home loan rates are behaving well post-taper announcement, making for a great opportunity to purchase or refinance.
Last Week in Review: Three Reasons Rates Might Have Peaked
After weeks of prices dropping and rates creeping higher, mortgage-backed securities (MBS) bounced sharply higher this past week – helping home loan rates improve week over week. Let’s break down three reasons why we might have just seen the highest rates in 2021 and what to watch for in the weeks ahead.
1.Opposite of the Herd
This past week, the 10-yr Note yield touched 1.70% for the first time since May and has since fallen sharply into the 1.50s%. If you watch business television, read articles online or listen to market watchers on the radio, you can hardly find a single person who doesn’t think rates will go higher.
It is during these moments when virtually everyone says something will happen that the opposite takes place. For instance, there was an article out recently saying “Buying on the dip is dead for stocks”. It was on that exact day that stocks rocketed higher once again and have not looked back.
Bottom line: If everyone thinks rates are going higher, do not be surprised if rates move lower.
2. Sell on the Rumor, Buy on the News
In the stock world, the saying is “buy on the rumor, sell on the news” – where stocks move higher in anticipation of good news and ultimately sell when the good news is announced.
We might be seeing the opposite in the bond market. This coming week, it is widely expected the Fed will announce a tapering or scaling back of bond purchases. The bond market knows this, and rates have been creeping higher for weeks.
Maybe, just maybe, we will see bonds continue to improve or at least not move lower once the Fed makes the official announcement next week.
3. Fed Rates Could Lead to Lower Long-Term Rates
Yes, you read that correctly. The Fed is going to announce bond tapering and wants to wrap up their pandemic-induced bond-buying by mid-2022. Once the Fed wraps up tapering, then they can proceed with possibly hiking rates.
Remember, when the Fed hikes rates, they are hiking the Fed Funds Rate, which is the overnight rate banks use to lend to one another. This rate affects short-term loans like credit cards, home equity lines of credit, and auto loans. A rate hike or rate cut by the Fed has no direct effect on long-term rates like mortgages, but it could help keep mortgage rates remain relatively low – here’s why?
The chance of a Fed rate hike in June 2022 is now at 60% up from just 20% one month ago. Persistently higher inflation is the reason why the probability of a rate hike is moving higher.
So, the Fed is going to hike rates, likely sooner than recently believed, because inflation remains stubbornly high. The rate hike is designed to tamp down inflation and prevent it from getting out of hand.
Do you know what likes tamped down or lower inflation? Yes, long-term bonds like MBS. Inflation is the archenemy of long-term bonds. If inflation moves higher, so do long-term rates. The opposite is true.
Bottom line: If you are considering a home loan, now is an amazing time. We shall see how MBSs ultimately react next week when the Fed announces the taper. If the bond market reacts poorly, we have technical levels we are watching, which would signal we are moving to an era of higher rates.
Last Week in Review: Three Things Moving the Markets
Interest rates ticked up week over week and are near the highest levels of 2021. Let’s break down three things moving the markets and what to watch for in the weeks ahead.
1. Buy on the Dip is Back
Stocks had a bad September, with the S&P 500 falling 4.8%, its worst month since March. After a multi-year rally with major indices doubling in value since March 2020. Many market analysts called for a much bigger drop in September.
It has not come to pass and in October, we are seeing investors jump back in and “buy the dip”, sending stocks to fresh historic highs. What has been the main driver of the stock gains?
Earnings, earnings, earnings. Many firms from the banking to the technology sector reported stronger than expected 3rd quarter earnings and maintained their future growth targets.
As stocks go higher, it is typically at the expense of bonds/rates as has been the case this month.
2. Fed Taper Cometh
November 3rd is just around the corner. That is the day the Federal Reserve meets and, likely announces their intentions to start tapering or scaling back their $120B monthly bond purchases.
The Fed started this bond-buying program in March 2020 to help stabilize the mortgage-backed security (MBS) market and help pin down long-term rates to stimulate the purchase and refinance market. Those goals have been met, so the Fed is ready to taper.
MBS prices have been moving lower the past few weeks in anticipation of the Fed taper announcement. Are we seeing a sell on the rumor and a potential buy on the news? Meaning, is the bond market moving lower on the news we expect to hear only to stabilize once the official announcement is made? It’s quite possible if history is any guide. Back in 2013, the bond market endured a “taper tantrum” when the Fed remarked about possibly scaling back purchases. However, when the Fed started the tapering many months later, MBS prices improved as did home loan rates.
This will be an important event and subsequent bond market reaction to follow as rates do threaten to move to the highest levels of the year.
3. Supply Chain Disruption
We are seeing shortages of many goods as the globe struggles to ramp up production to meet demand. Apple just announced they expect to sell far less of their iPhone 13s this holiday because of chip shortages.
On top of this, we currently have nearly 200 cargo ships floating in our waters waiting to be unloaded and shipped throughout the country. The problem?
We do not have enough people working in the ports and driving trucks to help move the goods throughout the country. It has been reported that we may need an additional 80,000 truckers here in the US just to get past this current supply chain disruption and meet demand.
What will be the effect? Scarcity and higher prices. It now appears the supply chain disruption is going to last well into 2022 and that means higher prices (inflation) will be more persistent.
Just this past week, the National Association of Home Builders said the supply chain problems have caused shortages in cement, drywall, and many other materials required to build homes. This will lead to even higher new home prices in the year ahead.
Inflation is the archenemy of bonds. If inflation remains stubbornly high, it will put upward pressure on rates, especially if the Fed is buying fewer bonds.
Bottom line: Home loan rates are testing the highest levels of the year. A price to move lower from here would usher in even higher rates.
Last Week in Review: The Cure for Higher Rates
Interest rates ticked up just slightly week over week. However, we might have seen a near-term peak in rates. Let’s break down what happened and talk about what to watch for next week.
1. Inflation Remains High
The Consumer Price Index (CPI) for September showed prices are remaining persistently high and challenging the Fed’s notion it will be “transitory”.
CPI showed prices climbed 5.4% year over year, matching the hottest pace in 30 years. The more closely watched Core CPI, which strips out food and energy costs, rose 4.0% year over year. The Federal Reserve has the mandate to maintain price stability (inflation). The Fed’s inflation target is to have core consumer prices run at 2 to 2.5% over the long run, so seeing prices running at nearly double that level is a concern if it is not transitory.
Inflation can increase when people “expect” to pay more. At the moment, both 5-yr and 10-yr inflation expectations are matching the highest levels of 2021. If those inflation expectations rise further, it will put upward pressure on rates. The opposite is true.
2. Fed Minutes Reveal the Taper Plan
Last Wednesday, the Minutes from the previous Fed meeting were released. This is where we get to read the dialogue amongst Fed members and their thoughts on the economy and monetary policy.
The most important takeaway was Fed Members agreeing to a timetable and plan to taper or scale back bond purchases. Here’s what the Fed said back in September:
“The illustrative tapering path was designed to be simple to communicate and entailed a gradual reduction in the pace of net asset purchases that, if begun later this year, would lead the Federal Reserve to end purchases around the middle of next year. The path featured monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS)”. This is a very gradual scaling back of purchases. It is also important to remember that the Fed will continue to buy bonds daily during and after the taper, with proceeds from their existing portfolio, so this truly is a “scaling” back and not an end to bond buying.
“Participants noted that if a decision to begin tapering purchases occurred at the next meeting, the process of tapering could commence with the monthly purchase calendars beginning in either mid-November or mid-December.” It’s clear the Fed will likely start buying fewer bonds this year.
3. The Cure for Higher Rates is Higher Rates
There were some signs that mortgage-backed securities (MBS), Treasuries, and even bonds abroad hit rate peaks – highlighting that at some point, higher yields attract investors.
For instance, last Tuesday, there was a big 10-year Note auction that showed very high buyer demand. MBSs, last Wednesday, hit the lowest levels since March, but then bounced sharply higher.
Lastly, the German 10-yr Bund touched – 0.08% on Wednesday, which matched the highest yield in over 2 years. Since that time, the Bund yield continued to decline and is currently at – 0.18%. As yields decline abroad, it puts downward pressure on our yields.
Bottom line: We are watching to see if rates might have peaked in the near term, despite persistently higher inflation and the likelihood of the Fed tapering this year.
Last Week in Review: Three Other Things Moving the Market
Interest rates have ticked up the past 10 or so days after the Federal Reserve told the financial markets there is broad support to scale back bond purchases and finish those purchases by mid-2022. Let’s talk about three “other” things moving the market between now and the next big Fed Meeting on November 3rd.
1. Debt Ceiling Debate
“We now estimate that the Treasury is likely to exhaust its extraordinary measures if Congress has not acted to raise or suspend the debt limit by October 18” – Treasury Secretary, Janet Yellen.
It’s that time again. Our country needs to borrow more money to help offset the enormous amount of federal spending now and into the near future. To pave the way, Congress must raise the debt ceiling. This measure is nothing new. We have raised the debt ceiling over 15 times in this century alone.
Like most things in Congress, it’s never a pretty process to watch and the past has shown some messy debt ceiling debates which did turn into some crises…but the limit was always raised.
In this politically charged environment, we should expect a lot of chaos and uncertainty as this process moves forward. Normally, chaos and uncertainty would help bonds, but they have not yet as the anticipation of the Fed tapering bond purchases remains an upward pressure on rates.
Note – Congress came to agreement on a stop-gap measure which will fund the government until December 3rd.
2. Infrastructure Spending Debate
On top of the debt ceiling debate, Congress is trying to push through $5T worth of spending through two different bills. It is not clear if and what will get passed. The plans do have an impact on rates and future Fed Reserve policy.
If any of the plans come to pass, the Treasury Department will have to issue new bonds to pay for the plans. Meaning, investors in the bond market must buy even more Treasuries each month than what is available today. This additional bond issuance can weigh on bond prices and cause an uptick in rates.
Should the entire $5T or so get passed, the Federal Reserve, which has been buying $120B in bonds every month to help keep rates low, may be forced to do more buying in the future. Otherwise, how can the US afford an uptick in rates with $29T in debt and growing? Someone must buy our debt.
3. Home Prices Record Rise
The Case Shiller Index showed home price rose 19.7% in July, a fourth consecutive record of home price gains. This kind of rapid growth is unsustainable and this “froth” in the housing market is the very reason why the Fed is being pressured to taper bond purchases, especially the purchases on the mortgage-backed security side.
An increase in rates would likely slow the price appreciation in homes. What is not clear is how it would affect affordability and overall demand over time.
Bottom line: We are now just a few weeks away from the next Fed Meeting and, at the moment, their policy response is the main driver of long-term rates. Should the Fed announce taper, rates may rise further. The opposite is true. Now is the time for folks to lock in long-term rates as a real threat of higher rates exists.
Last Week in Review: Fed Meeting Breakdown, Taper Cometh
Home loan rates ticked up and had a bit of a “taper tantrum” after the Fed meeting last Wednesday when Fed Chair Powell outlined the case to scale back or “taper” bond purchases. Let’s break down what was said and what to look for in the weeks ahead.
“Asset purchases still have a use, but it is time to taper them.” – Fed Chair Jerome Powell…Sept 22, 2021
The Fed has been purchasing $120B worth of Treasuries and Mortgage-Backed Securities since March 2020 to stabilize the financial markets and help pin down long-term rates. This effort has helped fuel the frenzy in both purchase and mortgage refinance activity.
Last Wednesday, during a press conference, Fed Chair Powell made it clear that the days of bond-buying are coming to an end and the scaling back of purchases may start before the end of the year. Here are some important quotes from the press conference:
“There is very broad support on committee for timing and pace of taper”
This is important as Fed Members are in alignment on the issue to taper, which means there is a good chance it is going to happen soon.
“There are some who would have preferred to go sooner due to financial stability concerns.”
This line highlights the fear that some Fed Members have of inflation/price instability that comes with too much money in the financial system.
“Wouldn’t put too much on inflation remaining above goal in Fed’s current outlook.”
However, Fed Chair Powell and most of the Fed believe the current high levels of inflation will be transitory or short-term in nature. The Fed forecasted Core inflation dropping down to 2.3% next year, which would be right in the Fed’s sweet spot. If inflation moderates to those levels, interest rates may not be pressured higher, which allows the Fed to scale back bond purchases.
“Completing taper sometime around the middle of next year will be appropriate.”
And for the first time, we have a timeline. The Fed is looking to scale back $120B a month in purchases to zero by mid-2022.
What’s next? Mark your calendar as the next Fed meeting is Wednesday, November 3rd…that is the day markets feel the Fed will announce the taper start if they want to complete the tapering by mid-2022.
For the Fed to make a taper announcement in November, we likely need to see more progress on the labor market, which means the September Jobs Report, being reported Friday, Oct 8th is a big deal. If that report is solid, expect the Fed to make the announcement. If the report stinks, as some have of late, the Fed may not announce the taper.
Other unknowns which might delay a taper announcement include the debt ceiling negotiation, infrastructure debate, and signs of Chinese property bubbles losing air.
Bottom line: Now we know the Fed wants to taper and it may come as soon as November. This means it is very difficult for rates to improve much if at all from here.
Home loan rates were mainly unchanged this past week. Let’s break down what is threatening the financial markets and rates.
The Taper Threat
A big threat to stocks, bonds, and rates is when the Fed will announce a tapering or scaling back of bond purchases. Presently the Fed has been buying at least $120B worth of Treasuries and mortgage-backed securities (MBSs) every month. This Fed buying is the main reason why home loan rates remain near all-time lows.
With inflation elevated and froth in the housing market, there is growing pressure on the Fed to start buying fewer bonds – and there is speculation the Fed will start tapering by purchasing fewer MBSs.
No one knows what, if and when the Fed will do anything, but if the Fed buys fewer MBSs, home loan rates will likely move higher. Back in 2013, when the Fed mentioned the word “taper” home loan rates shot up 2.5% over the next 6 months. The Fed knows this and is trying to scale back purchases without causing a similar disruption.
The next Fed Meeting Monetary Policy Statement will be released on Wednesday, Sept 22nd at 2:00 p.m. ET. We will find out soon enough if the Fed is confident enough to scale back bond purchases and not trigger a taper tantrum reaction in the bond market as we saw back in 2013.
The Tax Threat
The Administration and Congress are trying to pass a $3.5T spending plan that will include various tax hikes. There is a concern in the financial markets that a broad range of tax hikes could lead to slower economic growth, at a time when economic growth is already decelerating. Stocks don’t like the idea of slower growth and have been under selling pressure of late as details of the $3.5T plan have emerged.
Normally bonds and rates would do well when stocks suffer. But that has not happened this past week. Bonds are worried about the taper threat and the idea that a large $3.5T plan could put upward pressure on rates as the bond market has to absorb all the new bond issuance required to fund the enormous spending plan.
Much like the taper threat, no one knows how big the spending plan will ultimately be and what taxes will be included. Once something is close to being passed, stocks, bonds, and rates will react accordingly.
Bottom line: We do not know if the Fed will also announce a “modest” tapering in bond purchases next week or how the bond market will react. At some point, the Fed will have to scale back purchases and when it does, we should expect an increase in rates.