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There is definitely a chicken/egg problem when it comes to interest rate news. Is it the Fed’s decisions that raise rates? Or will market forces push rates up, thus forcing the Fed to react?
The answer lies somewhere in between. If inflation and economic growth were always positive, low and stable, the Fed would never lift a finger, but they are forced to act when stability is threatened.
Since March 2020, the Fed has largely taken action. They maintained rate-friendly policies for about 2 years and then turned sharply unfavorable in early 2022. “Unfriendly” in this case means raising the fed funds rate and buying fewer bonds on the open market. The combined effect was one of the fastest rate spikes in history.
Now after more than a year of camaraderie, the Fed is finally looking to level off and see how things go without too many rate hikes. He has already reduced the pace from 0.75% to 0.25% per meeting.
This is not a random decision on the part of the Fed. This comes in response to changes in inflation data as well as other signs that his unfriendly policies are having an effect on the economy.
The latest sign is the banking drama that has been in the news this week. It started with Silicon Valley Bank last week but became a bigger problem with the closure of Signature Bank over the weekend. Many people have never heard of these institutions, but they now represent the second and third largest bank failures in US history.
Many people have heard of Credit Suisse. While the European institution has been wobbling for months, markets reacted to the news that it too could be swayed by recent drama. The share price fell almost all week and other European banks went short in sympathy.
All of the above contributed to another week with an apparent “flight to safety” in the market. In very short terms, it involves selling risky assets like stocks and buying bonds. When traders buy bonds, this lowers interest rates (represented by the US 10yr Treasury yield in the chart below), all other things being equal.
Despite the apparent jitters in financial markets, the Fed will almost certainly continue raising rates when it meets next week. It would also almost certainly indicate that additional rate hikes are likely, if not possible, and that they depend heavily on the path of inflation, which will leave a handful of mismanaged banks with trouble coping with the tough rate environment. have to do.
When this happens, keep in mind that the market is less concerned with how the Fed changes rates at the current meeting and more interested in how the rate outlook develops for the coming months. This approach is driven by two things: the Fed’s stance on the economy and the economy itself.
By maintaining a tight stance on rates, the Fed makes it harder for the economy to experience strong growth. It also means that it will be difficult to experience a revival in inflation. This exerts downward pressure on rates in the longer term.
As of the current week, the decline in rates was driven not only by the flight to safety, but also by expectations that the Fed would be able to start cutting rates by the end of the year. This can be seen in the following chart with September’s fed funds rate expectations falling below March’s.
Unfortunately for the mortgage market, a classic flight to safety benefits Treasuries first and foremost, even though the 10yr Treasury is often used as a benchmark for mortgage rate movement. Mortgages have definitely improved – just not as noticeably as Treasuries.
That’s okay though. The most lasting improvements in mortgage rates are the ones that happen gradually. The housing market is already responding to the clear highs in rates seen in the chart above. Since the high in late 2022, housing metrics have gradually come down from their lows, as seen in the latest construction and builder confidence data released this week.
Both existing and new home sales for the month of February will be released next week, but when it comes to market movements and the impact on rates, all eyes will be on Wednesday afternoon’s Fed events.
Why events? It’s not just the Fed’s rate hike that happens on Wednesday. He will also have some updates on the wording of the policy announcement. Those words will help shape the policy path going forward. Markets will gain even more clarity and insight from updated forecasts for future rate hikes (or cuts?) presented by each Fed member. Those forecasts will likely run contrary to market expectations and it will be interesting to see how the market reacts when faced with that reality.
Last but not least, every Fed Day ends with the Fed Chairman’s press conference. It will be one of the most important and informative in recent memory as Powell will be forced to choose between policy goals and calming a potentially jittery market.
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