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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.

Last Week in Review: New Year, New Outlook

The first few trading days of 2023 saw an improvement in rates. Let's look at what happened this past week and brace for what is coming in the week ahead.

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

Last 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.

Last Week in Review: Market Themes as We Enter 2023

Home loan rates crept higher in the final week of 2022. Let's look at some themes that should bode well for housing in 2023.

Inflation Has Peaked

One of the biggest economic stories in the U.S. was seeing inflation hit the highest levels in over 40-years. The Federal Reserve, led by Jerome Powell, lifted short-term rates at the fastest pace in decades to combat inflation and help reach their federal mandate of price stability.

There are different monthly readings that track consumer inflation, including the Consumer Price Index and the Core Personal Consumption Expenditure Index. The good news is both readings have declined in recent months, suggesting we enter 2023 with the rate of inflation slowing. This is good news, because it will take pressure off Fed rate hikes and it will allow long-term rates, like mortgages, to continue to improve in 2023.

Recession Fears Elevated

At the December Fed Meeting, the Federal Reserve revised their economic growth forecast lower to just .50% in 2023. This means the economy is going to slow further and be at or close to a recession next year. What could tip the economy into a recession? Policy error. This is a fancy way of suggesting the Fed may hike rates too far or keep rates high too long.

The Treasury market, which is arguably more accurate than the Federal Reserve in forecasting economic conditions, is saying a recession is looming. The 3-month T-Bill has been yielding more than the 10-year Note yield. This has happened eight times since the 1960's and each time a recession came in the months thereafter.

The good news is if the economy is at or near the recession, it will help lower inflation, lower rates and make for a healthier housing market, with slower price gains.

Labor Market Remains Strong

Probably the brightest spot in our economy is the labor market, we finish the year with a tight 3.7% unemployment rate. We expect unemployment to tick up from here as the Fed wants unemployment to move higher and slow demand. Even still, an unemployment rate beneath 5.00%, which is what we should expect for the foreseeable future, is healthy and will support the housing market into the future.

The good news is, jobs buy homes and our labor market looks healthy heading into 2023. It may be strong enough to help our economy avoid a recession.

Bottom line: After a rough 2022 for interest rates and housing, there are many positive signals as we enter 2023, setting us up for a healthy housing market into the future.

Last Week in Review: Shrugging off BOJ Surprise

Home loan rates held steady near 3-month lows despite a negative surprise from the Bank of Japan. Let's discuss what happened and look into this week.

BOJ Surprise

Earlier this week, the Bank of Japan (BOJ) unexpectedly allowed its 10-yr government bond rates to rise. This sounds like a big deal on the surface, but let's break it down.

First, for many years, the BOJ has had a collar around their 10-yr bond, restricting it from going no more than .25% above or below 0.0%. On Tuesday, they announced they would widen the band and allow their 10-yr rate to float up to .50% above or beneath 0.0%. Yes, you read this right, the BOJ essentially went from having a .25% to having a rate as high as .50% which is a meager interest rate when you consider our 10-yr Note is yielding 3.65%.

To signal to the markets that the BOJ was not tightening monetary policy, they also announced that they will purchase more bonds (QE) to prevent yields from rising.

It's worth a reminder that here in the US our Federal Reserve is doing the opposite. They are no longer buying bonds and are allowing them to run off the balance sheet, hence the dramatic increase in rates this year.

Consumer Confidence Mixed

Consumer confidence bounced back in December, reversing consecutive declines in October and November to reach its highest level since April 2022. Why? Inflation expectations retreated in December to their lowest level since September 2021, with recent declines in gas prices a major impetus which is good for rates and less Fed hikes.

3.65%

The 10-year Note, which ebbs and flows with mortgage rates remained steady at 3-month lows, well off the 4.20% highs seen last month. Future inflation and labor market readings will determine if long-term rates continue to edge lower at the beginning of 2023.

Bottom line: Home loan rates have improved nicely from their peak in 2022 and inventory has increased in many parts of the country. Furthermore, sellers have become more realistic in pricing, and many are eager to make deals. This poses a wonderful opportunity for a would-be home buyer.

Last Week in Review: Fed Raises Rates and Home Loan Rates Improve

This week, the Federal Reserve raised the Fed Funds Rate by .50%, the smallest hike in over 6 months, and in response, home loan rates improved. Let's discuss the seemingly odd market reaction and what to watch in the week ahead.

"We've covered a lot of ground, full effects of tightening yet to be felt" - Fed Chair Jerome Powell - 12/14/22

This line from the Fed Chair's press conference highlights the Fed's action of smaller rate hikes as we approach what is the "terminal rate" or peak in the Fed Funds Rate.

The Fed Chair also reiterated that while the Fed is doing a smaller hike it is going to take time for the previous hikes to tamp down inflation pressures and elevate unemployment. And they will stay the course until the job is done.

Fed's Summary of Economic Projections

Every three months, the Fed revises its outlook on economic growth, inflation, unemployment, and the Fed Funds Rate. What does the Fed think about 2023, and what has changed since September?

The Fed now sees the economy growing by just .50% in 2023, well below the 1.2%, they forecasted 90 days ago.

On inflation, the Fed expects their favored measure, The Core PCE, to come in at 3.5%, above their previous estimate of 3.1%.

Unemployment is expected to be 4.6%, higher than the 4.4% they previously expected.

3.46%

It's a good time to remember that the Fed controls the Fed Funds Rate, which is an overnight lending rate, and their hiking activity has no direct correlation to home loan rates.

Long-term Treasury rates, like the 10-yr Note, move higher if the economy can absorb the Fed rate hikes. Seeing the 10-yr Note yield at 3.46% after the Fed raised the Fed Funds Rate to 4.50% tells us the bond market feels the slowing economic conditions are not supportive of higher rates and the Fed will have to change course at some point.

Bottom line: Home loan rates are at the best levels since September. Couple this with sellers eager to make deals and you have the recipe for an opportunity for nimble buyers.