A Look into the Markets
The first few trading days of 2023 saw an improvement in rates but the party was derailed by some good news. Let’s look at what happened this past week and brace for what is coming in the week ahead.
“You see I, I raise a toast to all of us who are breakin’ our backs every day” – Nothing But a Good Time by Poison.
Lower Than Last Year
Long term interest rates started the year moving lower, with both mortgage-backed securities (where home loans are priced) and the 10-year Note yield posting nice gains.
This is a bit different than what happened last year as when 2022 rang in, interest rates moved higher and never looked back.
Remember, the Federal Reserve controls the Fed Funds Rate which is an overnight rate. That interest rate, along with short-term rates like the 3-month bill and 2-year Note are all higher than the 10-year Note and 30-yr Bond rates. Historically, when short-term rates remain higher than long-term rates, it means a recession is on the horizon.
Good News is Bad News
Interest rates gave up some of their nice gains to start the year in response to a much better than expected ADP Report (labor market reading).
The good news on more jobs being created was bad news for rates as markets worry the Fed will continue with higher for longer rates and eventually tip the economy into recession.
The market response to the ADP report also elevated the chance of a .50% Fed rate hike to 50/50, up from a .75% chance of a .25% hike just a day earlier.
Ultimately, the strong labor market is great for housing and the overall economy as it would ensure that any economic recession would be shallow and short-lived in nature.
December Fed Minutes Released
This week, we also got to hear what the Fed was thinking and talking about at the December Fed Meeting, where they raised rates by a smaller .50%, breaking a string of four consecutive .75% hikes.
“Participants welcomed inflation drops in October, November but concurred it would take “substantially more evidence” of progress to be confident of a sustained downward path” – December FOMC Minutes.
This line from the Minutes is encouraging that inflation has indeed peaked but is a bit worrisome the Fed will be trying to keep rates higher for longer when inflation is already coming down. Remember, it was just back in November 2021 when the Fed admittedly got it wrong regarding high inflation. Could they get it wrong this time around?
Bottom line: Long-term rates appear to have peaked, but any further improvement will be based on the incoming data. We are seeing the threat of higher inflation being offset by the elevated threat of a recession.
Looking Ahead
Next week will bring a fresh round of Fed speeches which can move interest rates. But the main event will be the Consumer Price Index (CPI) for December, where it is expected to decline to 6.7% annually from 7.1% in November. Seeing that CPI was above 9% last summer, shows inflation is indeed declining, which is good.
Mortgage Market Guide Candlestick Chart
Mortgage-backed security (MBS) prices determine home loan rates. The chart below is a one-year view of the Fannie Mae 30-year 5.5% coupon, where currently closed loans are being packaged. As prices go higher, rates move lower and vice versa.
The right side of the chart shows prices moving in a multi-month sideways range near the best levels since September.
Chart: Fannie Mae Mortgage Bond (Friday January 6 2023)
Economic Calendar for the Week of December 19 – 23
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A Look into the Markets
This week, interest rates touched the lowest levels in two months on the idea that inflation may have peaked. Let’s break down what happened and look into Thanksgiving Week.
“Well I’m going down. Down, down, down, down, down” Going Down by Jeff Back
10-yr Note Touches 3.67%
The 10-yr Note yield touched 3.67% this week, a large rate improvement from 4.23% seen the previous week. The downtick in long-term rates also fed into home loan rates, which have declined as much as .50% in the last week or so.
The big question? Does this decline in rates have “legs” and will it continue?
Peak Inflation Equals Peak Rates
The readings on inflation suggest that we may have just seen the peak in inflation. We will want to see future inflation readings to confirm this, but long-term bonds, which are forward-looking, appear to be pricing at a peak.
Do not tell the Federal Reserve that inflation may have peaked. There were several Fed speakers out this week saying that inflation is still a problem, and they want to keep rates higher for longer.
Short-Term – Higher for Longer
Remember, when the Federal Reserve says they want rates higher for longer, they are talking about the Federal Funds Rate, which is an overnight rate that banks lend to each other. The Federal Funds Rate affects short term loans like credit cards autos and home equity lines of credit.
It is important to note that while the Fed Funds rate may increase by another 1.25% between now and next May, long-term rates like the 10-yr Note and mortgages, may have already peaked.
Smaller December Hike
The financial markets are now pricing in a high probability the Federal Reserve will only raise rates by .50% next month. Additionally, the markets are also sensing the Terminal Rate, or peak in the Fed Funds Rate will be 5 to 5.25% achieved by May of 2023. The Fed will attempt to lift rates that high and keep them there if the economic readings will support it.
Should we see the labor market struggle and inflation come down even further, the Fed may be forced to do less hikes. As the old saying goes, time will tell.
Bottom line: Home loan rates have improved. With more inventory coming to market and many sellers eager to make deals, now could be a great time to consider taking advantage of the opportunities in housing.
Looking Ahead
Next week we celebrate Thanksgiving, which means bonds are closed Thursday and only open a half day on Friday. There is also little in the way of economic data, with just Durable Goods Orders and Consumer Sentiment on Wednesday. There will be plenty of Fed speakers out to remind us of the need to hike rates more.
Mortgage Market Guide Candlestick Chart
Mortgage-backed security (MBS) prices determine home loan rates. The chart below is a one-year view of the Fannie Mae 30-year 5.5% coupon, where currently closed loans are being packaged. As prices go higher, rates move lower and vice versa.
You can see on the right side of the chart the Green Candles moving higher means a nice improvement in rates. For rates to improve further, we need to see MBS climb above $101, which will serve as a ceiling of resistance.
Chart: Fannie Mae Mortgage Bond (Friday Nov 18, 2022)
Economic Calendar for the Week of November 21 – 25