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Last Week in Review: Powell Visits Capitol Hill

This past week, Fed Chair Powell testified on Capitol Hill and his words sent rates higher. Let's walk through what happened and take a peek at what to watch next week.

"Rates Need to Go Higher, Faster"

Last Tuesday and Wednesday, Fed Chair Jerome Powell testified before both the House and Senate on the state regarding the economy and monetary policy.

His prepared speech set off fireworks in the financial markets on Tuesday as stocks moved sharply lower, and rates spiked once again. He started by suggesting that rates need to go higher and faster. This was a surprise as the Fed Chair recently said, "The disinflation process had begun." He had the markets sensing there would be possibly three more .25% rate hikes.

As of this writing, things have changed a lot. Now, there is a 69% change of a .50% hike at the March Fed Meeting in two weeks. Before the Fed Chair spoke, the chance of a .50% was just 25%. The threat of even more rate hikes elevated short-term rates (which move closely with Fed rate hikes) to the highest levels in 16 years.

2-Year & 10-Year Yield Curve Inversion Widens

With the 2-year Note yield spiking to 5.00% and the 10-year yield remaining beneath 4.00%, we witnessed the largest yield curve inversion since 1981. Why is this important? Yield curve inversions are typically accurate in predicting recessions. So, seeing the widest yield curve inversion in decades suggests the bond market is screaming that a recession is likely to happen within the next 12 to 18 months.

"We do not think we need to see a sharp increase in unemployment to get inflation under control." Powell

Here, the Fed Chair is trying to soothe the markets on the notion they can hike rates more to help lower inflation and avoid a large uptick in unemployment. Currently the labor market remains very tight. There are still nearly 11 million jobs available and nearly half that amount of people unemployed, so there is a 5 million gap between jobs available and people to fill those positions.

Let's hope the Fed Chair is correct and inflation will continue to come down and we do not experience significant unemployment...as jobs buy homes.

Bottom line: The uncertainty, confusion and volatility in the financial markets has elevated pessimism in the economy and housing. History has shown when pessimism or optimism elevates, it's generally a contrarian indicator and a change in sentiment is forthcoming. The other good news? Despite all the noise, both inflation and home loan rates have likely peaked.

Last Week in Review: Inflation and The Fed Dominate Markets

This past week, home loan rates touched their highest levels since November. Let's walk through what happened and mention the big events in the week ahead.

Global Inflation Remains High

Back in early February Fed Chair Jerome Powell stated that the disinflation process has begun and that's a good thing. Since that moment, the U.S. has endured several higher-than-expected inflation readings causing interest rates to spike to the highest levels since November.

This included the recent Q4 2022 Unit Labor Cost Numbers, which came in double expectations.

And if that were not enough, inflation across the pond rose to record levels causing global yields to rise. France, Spain, Germany and Italy all reported record inflation prompting markets to start pricing in more rate hikes ahead for the European Union.

The European Central Bank is now expected to raise their benchmark interest rate to 4%. It was not long ago where that interest rate was negative and as interest rates rise around the globe, it places upward pressure on our yields.

4%

Last Wednesday, the ISM Manufacturing Index was reported. And while the headline number was disappointing and shows the manufacturing sector contracting, the prices paid component or inflation reading was elevated. After several higher-than-expected inflation readings over the last few weeks, this report was enough to push rates higher, with the 10-year yield breaking a psychological barrier at 4%. With this break above 4%, market watchers' sense that the November highs of 4.20% will be tested.

Fed Tough Talk Is Back

On the heels of the hotter than expected inflation numbers, Federal Reserve officials were out in full force, reminding markets that interest rates will go higher for longer. Fed President Kashkari said, "If we declare victory too soon, there will be a flood of exuberance and we will need to do even more work (rate hikes)."

The financial markets are now pricing .25 basis point rate hikes in March, May, and June, lifting the Fed Funds Rate to over 5% for the first time since 2007.

The good news? The Fed's efforts to fight inflation, slow demand create some unemployment and lower asset prices is good for long-term bonds like the 10-year Note and Mortgage-Backed Securities (MBS). We will now watch carefully to see if MBS prices can remain above the November price lows and if the 10-year yield can remain beneath the closing peak of 4.20% last seen in November.

Bottom line: In the absence of market-moving economic data we should not expect any meaningful improvement in rates. The good news is the cure for higher rates is higher rates. Rates are near peaks seen in the Fall. The economy is slowing and all of the Fed rate hikes from last year have yet to hit the economy.

This Week in Review: Three Things That Happened Last Week

Last week, rates touched the highest levels since Fall. Let's walk through three things that happened and what to watch in the week ahead.

1.) Fed Meeting Minutes Released

Last Wednesday, the Minutes from the February 1st Fed Meeting were released. At that meeting, the Fed raised rates by .25% and in the following press conference, Fed Chair Powell said, "The disinflation process has started and that's a good thing." The smaller rate hike and disinflation reference were bond friendly at that time and led to the lowest rates since September.

Fast forward to today, the markets were on edge heading into the Minutes as we have since seen a surprisingly strong Jobs Report for January and a higher-than-expected inflation number, both of which lifted Fed rate hike expectations and mortgage rates.

The Fed Minutes ended up not mentioning disinflation whatsoever, but acknowledged prices have declined, but they need to see more progress (lower prices). Moreover, some Fed Members said there is an elevated threat of a recession in 2023. After the dust settled, rates remained elevated but stable.

2.) Inflation Rising Abroad

In Europe, Core inflation (ex food and energy) for January was revised higher to 5.3%. This now puts pressure on the European Central Bank to raise rates more aggressively like our Federal Reserve did last year with its string of .75% rate hikes. There is speculation the ECB will raise rates from the current 2.5% to 3.75% by September.

Why is this important to us? The bond market is global. If rates rise in other big bond markets like Europe, they increase here. The opposite is true. The markets will start watching to see if these economies slow materially because of the rate hikes. This would benefit long-term rates like mortgages. Currently, short-term rates are higher than long-term rates, which is generally a sign that economies are slowing, and the Fed must be careful not to hike rates too much and for too long.

3.) FHA Makes MIP Cut

The Department of Housing and Urban Development (HUD), through the Federal Housing Administration (FHA), announced a 30-basis point reduction to the annual mortgage insurance premiums (annual MIP) charged to homebuyers who obtain an FHA-insured mortgage. The premium will be reduced from 0.85% to 0.55% for most homebuyers seeking an FHA-insured mortgage, which could mean an estimated savings of $678 million for American families in aggregate by the end of 2023 alone. The reduction will benefit an estimated 850,000 borrowers over the coming year, saving these families an average of $800 annually.

Takeaway? This effort by the government to help with housing affordability should be applauded. This measure will help would-be homeowners.

Bottom line: We are revisiting the theme of 2022 where there was uncertainty and volatility about where inflation is headed, what the labor market will look like and what the Fed will do about it. Long-term rates still looked to have peaked, which is a good thing.

Last Week in Review: Inflation Lingering, Fed Officials Singing

Last week multiple inflation readings came in higher than expected and home loan rates ticked higher. Let's walk through what happened and what to watch in the week ahead.

"More upside inflation surprises could make Fed Policy more aggressive." Ohio Fed President Loretta Mester.

What happened? We thought inflation was on the decline. Even Fed Chair Powell just days ago said, "For the first time, we can say the disinflation process has started".

Inflation readings at the consumer and producer level did decline, they just simply didn't decline as much as expected. The shelter component, which includes rent, insurance, lodging (away from home and owners' equivalent rent of residences), makes up a sizable portion of consumer inflation which continues to run higher than 7% year over year.

One major way to knock down housing inflation is to build more homes. It is estimated we are several million homes short of what is needed to meet demand.

Homebuilder Outlook Improving, But...

The National Association of Home Builders announced an uptick in Homebuilder Sentiment to 42, a level last seen in September and right before home loan rates peaked in October and November. The downtick in rates in January fueled some of the optimism.

But, Building Permits and Housing Starts for January, both came in lower than expected. The Permits is forward looking as it shows authorization to build and ultimately leads to Starts, where the shovel goes in the ground.

We think of the Fed fighting inflation as part of their dual mandate of maintaining price stability. However, this problem will not be fixed by rate hikes alone, if at all. The lack of supply that can be filled by affordable home building could be addressed with fiscal policy at the County, State and National level.

Consumers Spent in January

Retail Sales, which measures consumer spending activity, came in much higher than expected. The markets initially hated the good news because it fuels the notion of more rate hikes. However, after a closer look, the markets saw one-time anomalies affecting the number, including an annual benchmark revision and consumers racing to spend holiday gift cards at vendors offering big discounts.

Going Higher

After all the news, the chances of more rate hikes went higher. The futures markets are now fully pricing in a .25% hike in March and May. There is also a 50% chance of another .25% hike in June, which would lift the Fed Fund Rates to 5.25-5.50%.

It is worth reminding everyone that Fed rate hikes have no direct correlation in mortgage or long-term rates. For example, the 10-yr Note yield, which has ticked up in recent weeks, along with mortgage rates, remains at 1.00% beneath the 3-Month Treasury Bill. The only way long-term rates go higher, is if the economy can absorb those rate hikes. The bond market continues to say it can't, so it likely won't.

Bottom line: Rates and inflation have peaked, but as we have seen the past couple of weeks, further improvement won't be a straight line. Expect further inflation and rate improvement in the weeks and months ahead as the Fed is committed to lowering inflation.

Last Week in Review: Fed Chair is Back After Strong Jobs Report

After last week's surprisingly strong Jobs Report, Fed Chair Jerome Powell spoke about the economy and direction of rates. Let's walk through what happened and what to watch in the week ahead.

"The strong Jobs Report shows you why we think this will be a process that takes a significant period of time." Fed Chair Powell 2/7/23.

The Federal Reserve has a dual mandate, which is to maintain price stability (inflation) and promote maximum employment. On the inflation front, it appears inflation has indeed peaked and is on the decline. The Fed Chair reiterated the "disinflationary process" has begun. This is a positive development for the economy, housing, and long-term rates.

On the labor market front of the Fed's mandate, the Fed in its desire to slow demand and thus inflation, wants to see some unemployment. The good news/bad news? Last week, the Bureau of Labor Statistics (BLS) reported the unemployment rate at 3.4%, the lowest in 53 years...that is good news. The bad news is it means the Fed will look to raise rates by .25% in March and another .25% in May, thereby lifting the Fed Funds Rate above 5.00%.

This renewed outlook for a higher Fed Funds Rate has elevated uncertainty and volatility in long-term rates, which move up and down based on economic conditions and inflation, both of which are easing and a reason why long-term rates are lower than short-term rates.

"Likely to see some softening in labor market conditions" - Powell

This is a reasonable assumption considering the number of planned layoffs announced this year, while we sit at multi-decade low unemployment, it seems like up is the only direction for unemployment.

Soft Landing Back in Play

Due to the current strength of the labor market, there is a growing chance the Fed can raise rates and lower inflation towards its 2.00% target without triggering a deep recession.

History has shown that recessions do not take place with unemployment at 4% or below without some sort of surprise shock to the economy.

Let's hope the Fed is not too successful in "creating" unemployment because if it quickly rises, the idea of a soft economic landing could go away quickly too.

3.70%

As we mentioned, long-term rates have responded negatively to last week's strong jobs report, because good news is bad news for bonds and rates. The 10-yr Note touched 3.33% last Thursday and touched 3.70% just a few days later. However, rates remain beneath where the 10-yr yield opened 2023 at 3.85%.

"We are going to react to the data" – Powell

Here the Fed Chair reminds the markets that last Friday's Jobs report was strong, but backward looking and lagging while other economic indicators show signs of s slowdown. The Fed does not want to over hike rates into a slowing economy and be the reason for the recession. So, while the market is currently pricing in two more rate hikes and a rate cut in December, this story could quickly change once again.

Bottom line: Rates and inflation have peaked. Housing activity has jumped in the past weeks as a result. The incoming data will determine how much better rates can get in the next few weeks leading to the next Fed Meeting.

Last Week in Review: Fed Hikes, Market Likes

This past week the Fed hiked rates by .25% and home loan rates improved to their best levels since September. Let's walk through what happened with the Fed and talk about what to watch in the week ahead.

"We can now say for the first time that the disinflationary process has started. This is a good thing." Fed Chair Powell 2/1/23.

As expected, the Federal Reserve raised the overnight Fed Funds Rate by .25% to a range of 4.50 to 4.75%. The Fed Statement and subsequent press conference also contained "dovish" tones where the Fed offered hope that inflation is headed lower and future hikes would be dependent on the incoming data.

"We haven't made a decision on exactly where rates need to end up." Jerome Powell.

Here, the Fed Chair was non-committal on where he sees the Fed Funds Rate reaching the terminal rate or peak. In his press conference, he reminded everyone the Fed will release their updated quarterly economic projections and forecast for rates. Meantime, the financial markets have their own idea of where rates are headed and are pricing in multiple rate CUTs later this year.

This means in the months ahead we should expect uncertainty and volatility as economic reports are released and Fed officials speak.

3.33%

Last October, the 10-year Note yield, which moves up and down with home loan rates, was 4.30%. Four months later, the yield has declined sharply to 3.33%. It is important to note the 10-year yield does have an important technical barrier right at current levels which may limit how much better rates can get in the near term. The trend for longer-term rates remains lower which is a good thing.

Labor Market Resilient

"By many, many indicators, the jobs market remains strong." - Powell.

The JOLTS report showed 11.1M jobs available and with 5.7M people unemployed, we have a nearly 4.5M person shortfall to fill open positions. The latest first-time unemployment claims are also at multi-decade lows, which further highlights the continued strength of the labor market.

This is great news for housing and the notion the economy can land softly and avoid a recession.

Bottom line: Rates have continued to improve since the start of the year. Couple this with continued strength in the labor market and you have multiple reasons to see housing sales improve going forward.

Last Week in Review: Good Economic News is Good News

Interest rates hover near the best levels since September, despite several good economic readings reported. Let's discuss what happened and see what is coming next week.

Economy Grew to Finish 2022

Gross Domestic Product, a measure of economic growth, for the Fourth Quarter 2022 showed the economy expanded at a 2.9% annual rate, down slightly from the 3.2% rate in the Third Quarter 2022. Seeing the economy grow in the back half of 2022 after negative growth in the first half of 2022 is good news.

This positive reading elevates the chance of a "soft landing" by the Fed, where they hike rates to slow inflation but do not slip us into a recession.

Unemployment Line is Historically Short

Initial Jobless Claims for December came in at 186,000...the lowest reading in 9 months. This is also good news as it tells us the length of the unemployment line. If the amount of people signing up for first time unemployment benefits remains near historical lows, it further lowers the chance of a recession. Moreover, it highlights the continued strength in the labor market, and this is paramount as jobs buy homes. Yes, we want interest rates to move lower but if someone doesn't have a job or is in fear of losing their job, they can't commit to a home purchase. Let's hope the labor market remains strong as the Fed continues to hike rates to slow demand and lower inflation.

New Home Construction Costs Coming Down

The National Association of Homebuilders reported that building materials costs, less energy, are up 8.3% which is a big increase annually. However, the price growth is down a staggering 60% as input costs increased over 16% in 2021.

We should expect input cost growth to slow further in response to slower demand and further reopening of supply chains. This is another positive theme as we move through 2023.

Smaller Fed Rate Hike Still Priced In

One of the headwinds to the economy is the threat of higher short-term rates by the Federal Reserve. The good news there? After four consecutive .75% rate hikes, followed by a .50% hike in December, the financial markets are fully pricing in a smaller .25% hike at next week's Fed Meeting.

The markets also believe the Fed will raise rates by another .25% in March and then pause to allow all the hikes that date back to last summer to seep into the economy.

This means the Terminal Rate, or the fancy way of saying the peak in the Fed Funds Rate, is going to be in a range of 4.75- 5.00%. From there we will have to continue to watch the standoff between the Fed who says they want to keep rates higher for longer. Additionally, with no rate cuts this year versus the financial markets, which are starting to "price in" as many as two rate cuts later this year.

Bottom line: The economy is showing mixed signals, but the labor market remains strong, and we are nearing the end of Fed rate hikes. So, the plan to land the U.S. economy softly and avoid a deep recession remains very much in play. That is good news for housing and the economy.

Last Week in Review:  Bad Economic News is Bad News

Bad economic news helped home loan rates touch the lowest levels in months. Let's discuss what happened and see what is coming next week.

Producer Prices Are Falling

The Producer Price Index, which is an inflation reading on what producers/wholesalers pay for goods and services, showed a larger than expected decline. It was also the lowest reading since March 2021.

This is good news, because if producer prices fall, it leads to consumer prices falling, which leads to lower rates and less Fed rate hikes.

It appears that both inflation and long-term rates have peaked.

Weak Economic Data Elevates Recession Fears

A bunch of weaker than expected economic reports cast a dark cloud over stocks, with bonds and rates the beneficiary.

Manufacturing reports in New York and Philadelphia highlight an economic slowdown and a very weak Retail Sales number for December, showing the consumer cutting back on spending.

In the recent past, stocks had moved higher in response to weak news on the notion the end of Fed rate hikes is near. But this week, stocks slid lower on the bad news because the bad news may also mean a recession and not just the end of Fed rate hikes.

Last Thursday, the 10-yr Note yield touched 3.32% for the first time since mid-September which suggests the bond market sees a slowdown and the need for the Fed to stop hiking rates.

The Standoff Continues

The Federal Reserve and the bond market disagree on the Fed's position on rates. The Fed says it wants to keep rates higher for longer, yet the sharp decline in long-term rates and wide yield curve inversions is the bond market saying the Fed is wrong.

The good news? The markets are now pricing in a .25% Fed rate hike on February 1st. We could very well see just one more .25% rate hike in March but that will be based on the incoming data.

Bottom line: Home loan rates continue to drift lower; sellers are eager to make deals and the labor market is strong. Now is a great time to highlight the current "buyers' market" while it exists.

Last Week in Review: Inflation Declines Again

Home loan rates held steady near the best levels in months after another decline in inflation. Let's look at what happened this past week and brace for what is coming in the week ahead.

December Consumer Price Index (CPI)

The headline Consumer Price Index, which includes food and energy prices, came in -0.1% for the month of December, which lowered the annual rate to 6.5%. The month-over-month decline was the first negative reading since December 2020.

Inflation is a main driver of long-term rates and is closely watched by the Fed, so seeing prices decline was a welcome sign for both.

The markets agreed. After the CPI report was released, the probability of a .25% rate hike on February 1st spiked to 87%. So, the markets are now expecting smaller and less Fed rate hikes.

Markets Are Forward Looking

The 10-yr Note yield, which does ebb and flow alongside mortgage rates, touched 3.46% after the report, the lowest level since early December. Long-term rates are forward looking and seeing where inflation is headed, which is lower. If inflation continues to decline, we should expect long-term rates like the 10-yr Note and mortgages, to decline as well.

Fed Jawboning Not Working Like 2022

Last year, home loan rates spiked higher and quickly in response to tough Fed talk or jawboning. So far this year, tough Fed talk is not having the same effect. Even though the Fed is currently saying they will keep rates higher for longer, long-term rates have ignored their words and continued to improve.

This is a reminder that long-term rates will only go higher if the economy can absorb all the rate hikes. The Treasury market is clearly saying the economy can't handle higher for longer rates without tipping into an economic recession. Like the famed investor, Jeffrey Gundlach, shared this week, "Watch Treasuries to follow Fed rate hikes and do not listen to the Fed".

Bottom line: 2023 has started with an improvement in rates, which is the opposite of what happened last year. With sellers eager to make deals, now is a great time for a buyer.