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Last Week in Review: Brainard and Fed Minutes Move the Markets

This past week, home loan rates touched the highest levels in three years in response to the same theme…inflation fears and forthcoming Fed rate hikes, and balance sheet reduction. Let's discuss what happened and what to watch for next week.
"Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017-19." Fed Governor Lael Brainard.
This was the quote that changed interest rates in a "New York Minute." Why? Governor Brainard expects to shrink the balance sheet larger and faster than they did back in 2018.
Balance sheet reduction/Quantitative Tightening (QT) explained:
The Federal Reserve has nearly $9T worth of Treasuries and Mortgage-backed securities (MBS) on its balance sheet, with an outsized portion coming in the last two years as the Fed purchased $120B of bonds per month for most of 2020 and all of 2021 in a process called Quantitative Easing (QE).
QT is the opposite of QE and a process where the Fed removes bonds off its balance sheet. MBS, where home loan rates are derived, can be paid off either through refinance or purchase activity or from maturation. When the Fed receives this principle, they have been using those proceeds to purchase more MBS. That will no longer happen.
In QT, the Fed will set a cap that will increase every month and ultimately get to $35B. The Fed will take the principal up to $35B and give it back to the Treasury Department. Any principal received in a month above $35B would be reinvested back into MBS.
The idea that the Fed would go from buying bonds to "rapidly" removing them from their balance sheet spooked the financial markets. History tells us the financial markets may be over-reacting to the idea the Fed is going to shrink its balance sheet (QT) and push rates much higher. Back in 2018 the Fed shrunk its balance sheet modestly and rates did move higher, but by the time the Fed stopped in mid-2019, home loan rates were lower than when they began.
Much like in 2018, we should expect any balance sheet reduction to be gradual with the Fed quickly adjusting based on incoming economic data much as they did back in 2019.
"A large number of members held the view that the current high level of inflation and its persistence called for immediate further steps towards monetary policy normalization," European Central Bank Meeting Minutes April 7, 2022.
What happens around the globe can affect our rates. This quote from last Thursday, where the ECB is moving away from its current accommodative policy to something more neutral, lifted yields abroad and caused our rates to tick up.
The next Fed meeting on May 4th is still weeks away. We should expect continued interest rate and market volatility over these next few weeks as we look to see how much the Fed will hike rates and if they start the balance sheet reduction (QT).
As of this writing, one positive development was the yield curve is no longer inverted. For a few days, the 2-year note yield was higher than the 10-year yield. Fears are that this 2/10 yield curve inversion portends a recession. However, history has shown that yield curve inversion typically last weeks or months before any recession. In this instance, the yield curve inverted for just a few days.
Bottom line: Interest rates remain on the rise and the words of central bankers around the globe last week have added to the uncertainty and volatility. If you are considering a mortgage, now is an ideal time to lock in your rate, as the path of least resistance for rates remains higher.

Last Week in Review: Tailwinds From Abroad
This past week, home loan rates improved from the worst levels in three years. Let's walk through what happened last week and talk about what to watch in the weeks ahead.

1. Ukraine/Russia Showing Optimistic Signals
Early in the week, there was word that the Russian military was going to deescalate their troops' presence around the Ukraine capital of Kyiv. Adding to the sense of optimism was also word the peace talks in Turkey between Ukraine and Russia officials were apparently positive.
Presently, there is no ceasefire and no deals in place. However, the markets sense the conflict moving towards a more positive resolution. In response, oil prices initially moved sharply lower - helping stocks to rise while rates declined.
The drop in oil prices ended up being short-lived but the rally in bond prices continued as the financial markets started to direct their attention to economic data and what the Fed will do with short-term interest rates.
It's also important to remember when looking at economic data and conditions, we also must look abroad, as what happens elsewhere can have a major effect on the US economy. Think - global supply chain crisis.
"Europe is entering a difficult phase," European Central Bank President Christine Lagarde.
The Ukraine/Russia war is causing both energy and food inflation in the region to increase. On top of this, the Covid related shutdowns in Asia are renewing the global supply chain crisis.
As costs remain high, Europe is also experiencing slower economic growth, which makes for a "difficult phase."
One way for the ECB to combat higher prices is to raise rates. However, slowing economic growth makes it difficult to do so as higher rates would slow growth further and potentially cause a recession.
So, the ECB will only raise rates gradually and carefully while adjusting policy upon receiving economic feedback.
As Europe's interest rates remain low, it pulls our interest rates lower as well. This is part of what happened this week.
2. The US Treasury Yield Curve is Speaking
Last week, the 2-year Note yield briefly broke above the 10-year yield causing a yield curve inversion. Economics tells us if the yield curve inverts for a sustained amount of time, we could be headed towards a recession within the next 18 months.
There are no recessionary signals sighted yet, but the yield curve is telling our Federal Reserve to be careful with rate hikes and tightening of financial conditions.
The 2-year yield does follow the Fed Funds Rate (the rate the Fed hikes and cuts) over time. Presently, the 2-year yield is 2.31% which suggests the Fed will raise the Fed Funds Rate by 2.00% from here.
The 10-year yield, just slightly higher at 2.33%, suggests that the Fed will not have much room to hike rates beyond the current forecast.
The incoming economic data, including reads on inflation and growth, will determine what the Federal Reserve will be able to do with rates.
Bottom line: Federal Reserve rate hikes have no effect on mortgage rates. We experienced a rate improvement last week for the reasons explained above. These themes can change quickly for the better or worse. If you are considering a mortgage, now is the time as any further improvement in rates could prove fleeting.

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Last Week in Review: Rates Spike on Tough Fed Talk

Home loan rates ticked up to fresh three-year highs as a parade of Federal Reserve officials spoke throughout last week about the need to hike rates more aggressively to combat inflation. Let's walk through what happened last week and talk about the big reports this week.
"There is an obvious need to move expeditiously to a more neutral level and more restrictive levels if needed to restore price stability," Fed Chair Jerome Powell – 3.21.22.
This quote, along with several others from Mr. Powell sent the bond prices lower and rates touching three-year highs. It suggested the Fed will need to hike the Fed Funds Rate quickly to get to a more neutral rate, where the Fed Funds Rate neither hurts nor helps the economy. Presently, the Fed Funds Rate is between .25% - .50%.
What would be a neutral rate? Atlanta Fed President Bostic, who was also speaking this week, said the neutral rate is 2.40%. So, this means the Fed wants to hike the Fed Funds Rate by 2.00% or 8 more .25% hikes to get to Bostic's neutral rate.
Mr. Powell also said they could move to more "restrictive levels," which would mean even more rate hikes and a Fed Funds Rate higher than 2.40%.
"Risk is rising. An extended period of high inflation could push longer-term expectations uncomfortably higher." Jerome Powell.
This quote speaks as to why long-term rates have risen so fast of late and why the Fed is speaking so tough this week. The major fear of the Fed is for long-term inflation expectations to rise – meaning, people will expect higher prices in the future. If people expect higher prices, we will see higher prices. This disruption to price stability is exactly what the Fed wants to fight.
Housing Already Seeing the Effect of Higher Rates
New Home Sales for February showed sales of newly built homes decline from a downwardly revised January number. Overall, New Home Sales are down 6.2% from February 2021.
NAHB Chief Economist Robert Dietz said, "New home sales softened in January and February as mortgage rates increased."
A new home sale occurs when a sales contract is signed, or a deposit is accepted. The home doesn't have to be built or even started to be considered a new home sale. Of the 407,000 new homes available for sale only 35,000 are built and ready to be occupied.
The median home price of a new home rose to $400,600, up 10.6% from February 2021, despite a sharp 20% increase in building materials over that time.
It's clear that housing has cooled a bit, which is exactly what the Fed wanted. What remains unclear is if, when, and how much the Fed could hike rates as an interest rate sensitive sector, like housing, has already slowed down.
Bottom line: The tough Fed talk hurt long-term rates like mortgages, last week. It remains to be seen if the Fed can act as tough as they talk. If you, a family member, or a friend is considering a mortgage, now is a great time as rates remain below the rate of inflation ... something that hasn't happened in nearly 50 years.

Last Week In Review: We Have Liftoff

Interest rates hover near three-year highs as the Federal Open Market Committee (FOMC) raised the Federal Funds Rate by 0.25%. This was the first rate hike in three years. Let's break down what the Fed said in their Statement and press conference and look at what the future may hold.
"The Committee seeks to achieve maximum employment and inflation at the rate of 2% over the longer run. With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2% objective and the labor market to remain strong. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting."...FOMC Statement March 16, 2022.
So, the Fed raised rates by .25% and said there will likely be more rate hikes to follow at some point in the future. Additionally, they expect to begin reducing its holding of agency mortgage-backed securities at a coming meeting. What does it all mean?
The Fed rate hike and subsequent rate hikes will have no direct effect on mortgage rates. Fed rate hikes only affect short-term loans like autos, credit cards, and home equity lines of credit.
If the economy is strong enough to absorb six more rate hikes this year, which is the current forecast, then we should expect long-term rates like mortgages and the 10-year Note yield to move higher.
Fed Chair Powell in his post statement press conference said multiple times, the economy is strong enough to absorb multiple rate hikes and there is no threat of a recession.
Time will tell whether the Fed will be able to raise rates that many times. Back in 2018, when Consumer Sentiment was at a 20-year high, the Fed raised rates four times and ended up cutting rates in 2019. Now in 2022, we are led to believe the Fed has the room to hike rates seven times, despite consumer sentiment hovering at 11-year lows and recessionary levels.
"We will take the necessary steps to ensure that high inflation does not become entrenched. We're fully committed to bring inflation back down. High inflation takes a toll on everybody" Fed Chair Jerome Powell.
Part of the "necessary steps" may be for the Fed to shrink their balance sheet and more specifically, remove their holding of mortgage-backed securities (MBS). Currently, the Fed has about $2.7T worth of MBS on its balance sheet.
Here's how the Fed explained it to us back in January and how they intended to reduce their MBS holdings.
"The Committee intends to reduce the Federal Reserve's securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA)."
This means when mortgages are paid off through maturation, moving, or refinance – the Fed will no longer use those proceeds to purchase more MBS. This is important because if the economy is strong enough for the Fed to do this, then we should expect mortgage rates to increase over time as the Fed goes from being a buyer of mortgages to a seller of mortgages.
What is the bond market saying?
If you look at the spread between the 2 and 10-year Note yields ... it is just 20bp. The last time it was this narrow, the Fed was CUTTING rates six months later. History has shown that almost every time the 2-year yield inverts or moves higher than the 10-year yield, it precedes an economic recession.
The good news? The Fed knows this and is watching the market's reaction very closely as they did back in 2018. Fed Chair Powell also said numerous times they will take action carefully to avoid pushing the economy into a recession. The rest of this year will be volatile as the bond market reacts to economic reports and how it will influence Fed rate hikes and the potential balance sheet reduction activity.
Bottom line: Fed Rate hikes have no direct impact on mortgage rates. So, despite the Fed raising rates by .25%, home loan rates remain stable for now. If you, a family member, or a friend is considering a mortgage, now is a great time as rates remain just beneath the 2022 peaks.

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Last Week in Review: Rates Edge Higher as Inflation Expectations Rise

Interest rates ticked up this week, despite the ongoing and uncertain Russia/Ukraine war. Let's break down what happened this past week as we prepare for an important Fed meeting.
This is probably a good week to remind everyone that inflation is an economic killer. When inflation fears rise both stocks and bonds perform poorly with rates rising.
Last Tuesday, President Biden sanctioned Russian energy including coal, natural gas, and oil. On the latter, this measure caused oil to touch nearly $130 a barrel. This increase has led to gas at the pumps hitting a historic high of $4.25. Oil and gas at these levels are highly inflationary in the absence of a material and sustained decline.
If this was not enough, commodity prices are soaring in response to the uncertainty. Wheat, lumber, copper, nickel...you name it and it's trading sharply higher, leading to higher costs on goods through the supply chain and down to the customer.
An important metric to track is the 10-year break-even rate, which essentially is what the US bond market expects inflation to average over the next 10 years. That number has climbed sharply over the past week and is the main reason why the 10-yr note yield and mortgage rates increased this week.
How do we lower and fight inflation? The Fed's mandate is to "maintain price stability "or inflation, so the financial markets will look to what they say at next week's Fed meeting. 
The Federal Reserve is in a tough spot.
The Fed Chair recently said they are going to hike rates several times this year and more next year. It sounded like a reasonable plan a few months ago, but our economy has since been punched in the mouth with Omicron, continued supply chain issues, labor shortages, and fast declining consumer sentiment.
Moreover, and most importantly, a Fed rate hike is intended to draw money out of the economy to restore the balance between supply and demand. Right now, the sharp rise in oil is accomplishing the same goal as Americans continue to spend more money on gas to fill their car and heat their homes. This added cost to consumers is already draining savings, lowering sentiment, and coming at the expense of other purchases.
Oh, wait...now factor in the Ukraine/Russia war. This has elevated prices further. Wheat is a major product supplied by Russia and Ukraine...those prices are soaring and may stay quite elevated for some time, thereby slowing consumer spending on other items.
Consumer spending makes up two-thirds of our economic growth or GDP. If energy, food, and commodity prices remain elevated, we should expect GDP to stall.
As you can see, consumer demand is already fragile and slow. Fed Rate hikes will only slow the economy further.
Lastly, look at the 2/10 year note yield spread. It is narrowing every day and down to the smallest margin since 2018 which could signal an economic slowdown. Back at that time the Fed hiked rates too much and ended up cutting rates in 2019.
Here we are in 2022, and the Fed "says" they are going to hike rates several times with a similar-looking 2-year vs.10 yield spread as 2018. Time will tell if, how much, and when they can hike.
Bottom line: Fed Rate hikes have no direct impact on mortgage rates. So, when the Fed hikes rates next week, it will not have a .25% hike to Mortgage rates. If you, a family member, or a friend is considering a mortgage, now is a great time as rates remain just beneath the 2022 peaks.

Last Week in Review: Big News Sparks Big Moves

Interest rates retreated from 2019 peaks as the Ukraine invasion by Russia escalates and grows more uncertain. However, there were other big developments here at home that erased a good portion of the rate improvement. Let's break down what happened and what to look for in the week ahead.
1.) Ukraine Invasion Market Reaction
The Ukraine/Russian war has escalated, and the outcome remains highly uncertain. No one knows if, when, and how this will end. When the world experiences tense geopolitical moments, it drives what is called a "safe-haven" trade into the relative safety of the US Dollar and the US-denominated assets like Treasuries and mortgage-backed securities (MBS).
Last Monday and Tuesday interest rates moved sharply lower, with the 10-yr Note declining from 2.00% to touching 1.69%. MBSs also improved nicely but the gains were not in lockstep with the ultra-safe haven of the Treasury market. Meaning, when the world is highly uncertain, Treasury rates improve faster and further than home loan rates.
The longer this war continues the longer we should expect rates to remain near or lower than current levels as the situation puts a bid or support under the bond market.
2.) Fed Chair Powell Testifies Before Congress
Last Wednesday was bad for bonds/rates which gave up half a sizable portion of their multi-day rate improvements. The main catalyst was Fed Chair Powell, who provided his semi-annual testimony before Congress.
"Reducing our balance sheet will commence after the process of raising interest rates has begun and will proceed in a predictable manner primarily through adjustments to reinvestments." Fed Chair Jerome Powell prepared testimony on 3/2/22.
This line reiterates the Fed's desire to remove MBSs from their balance sheet. The Fed currently has $2.7T of MBSs on its books. If the economy remains strong and can absorb multiple Fed rate hikes, then the Fed will try to become a seller of MBSs. The MBS market didn't like these words despite all the uncertainty in Ukraine and home loan rates shot higher in response.
"The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain. Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook."
Here, the Fed is telling us the uncertainty in Ukraine could lead to fewer rate hikes. Stocks liked it and soared higher, at the expense of bonds and rates.
Lastly, the Fed essentially told Congress that it expects a .25% hike in a couple of weeks. This removed the uncertainty that the Fed may go with a .50% hike. Stocks liked this and bonds did not.
3.) Soaring Oil Prices
Oil touched $116 a barrel last Thursday. If there was ever a time to have high prices "transitory", let's all hope this dramatic increase in oil prices proves to be short-lived. High energy prices are an economic killer. It is already weighing on consumer sentiment, and should it continue, it will weigh on consumer spending, which makes up two-thirds of our economic growth.
The Federal Reserve will be factoring in the high oil price and its economic impact as they consider rate hikes and ultimately shrinking their balance sheet.
Fed rate hikes are designed to slow demand and thus lower prices. If the consumer retreats on their own due to higher energy prices, the Fed may not be able to hike as aggressively as they intended when the year began.
Bottom line: This new Russian/Ukraine war changes everything. If you are considering a refinance or purchase transaction, now is the time when there is a lot of uncertainty. Upon better days ahead, we should expect somewhat higher rates.

Last Week in Review: The Elephant in the Room
Interest rates improved slightly this week in response to the Russian invasion of Ukraine. This story is evolving every moment and the current uncertainty is helping bonds and rates. Let's discuss what this all means for our economy and the Federal Reserve's actions.

1.) Safe-Haven Trade is On
When bad geopolitical events take place, like Russia attacking Ukraine, global funds seek the "safe-haven" of the US Dollar and Treasuries, with mortgage-backed securities (MBS) also seeing higher prices and lower yields.
All risk assets, like stocks and cryptocurrencies, are selling off with the proceeds being parked in cash and Treasuries.
We don't know how long the Russia/Ukraine war will last and we can only hope and pray for limited human toll and relative containment. As the story evolves, from minute to minute, it will move the financial markets. If the story worsens, we should expect rates to continue to track at or better than current levels. However, any signs of improvement in the situation would unwind some of the safe-haven trade causing rates to move back up.
It is worth noting, at the time of this writing, the improvement in rates has been quite modest given the magnitude of negative sentiment and uncertainty surrounding the invasion.
Let's hope the sanctions applied to Russia move the needle and help push the story in a positive direction.
2.) Further Pain at the Pump
Upon word of the invasion, oil prices hit $100 a barrel. This is awful for our economy. It will lead to another rise of gas at the pump and, just before the busy summer driving season. A Summer that is likely to be a bit more normal with Omicron and Covid moving behind us. There will be enormous pressure on our government to take measures to lower oil prices. If oil remains at or higher than current levels, it will hurt consumer spending which makes up two-thirds of our economy. Think about it – if people are putting more money in their tank or spending more to heat their home, it will come at the expense of other goods and services.
Oil is in everything, especially so in housing. It takes oil to build and deliver tons of materials. In the era where 7 out of 10 families are currently unable to qualify for a median-priced new home, sustained high oil will only exacerbate this problem.
Let's hope our government has a solution to provide meaningful and sustained relief, or we could experience an economic slowdown with higher prices – the very definition of stagflation.
3.) Fed Uncertainty Escalates Further
The Fed entered 2022, much like it did back in 2018, with a hawkish tone and a desire to raise rates several times. Back in 2018, the Fed raised rates three times which slowed the economy and hurt consumer sentiment.
Presently, the backdrop has gotten rather bleak. Consumer Sentiment is presently at an 11-yr low, and this is not factoring in the Russia/Ukraine war and Oil at $100. Additionally, financial conditions have already tightened, and small business sentiment has declined. These are not conditions in which the Federal Reserve wants to, nor can, hike rates multiple times.
The probability of a .50% rate hike has gone from 100% to just .15% in the span of the week. So, the Fed will hike rates next month by .25% to help fight consumer inflation, which is running at 7.5%.
What will the Fed do later this year? Will inflation rise further and force the Fed to do more? Can the Fed really do more? These are all big unanswered questions that will not be figured out until time passes. Until then, expect high volatility and push/pull market action between a safe-haven trade (good for rates) and high inflation (bad for rates).
Bottom line: This new Russian/Ukraine war changes everything. If you are considering a refinance or purchase transaction, now is the time when there is a lot of uncertainty. Upon better days ahead, we should expect somewhat higher rates.

Last Week in Review: Three Reasons Why Rates Might Have Peaked

Interest rates ticked up to their highest level in over two years but were able to finish the week off of the highest levels. Could rates have peaked? Let's discuss why this may be so and look ahead to next week.
1.) Financial Conditions Have Already Tightened
Part of the Fed's mandate is to maintain price stability (inflation). The Fed helps lower inflation by raising the Fed Funds Rate, which tightens monetary conditions and slows economic demand. If demand slows, prices come down.
Even though the next Fed Meeting is still one month away, and the Fed has not hiked rates since 2018, financial conditions have already tightened. The hawkish rhetoric and threats of multiple rate hikes have pushed up rates over the past 2 months to the highest levels in years. This has already had an impact on housing.
Of course, refinance mortgage activity is down sharply and that is to be expected with 30-yr rates up nearly 1% this year.
Now we are seeing an impact on new home sales. When you combine the lumber inflation, additional supply chain-related costs, and the recent uptick in rates, the National Association of Homebuilders reports that nearly 7 out of 10 borrowers can't afford a new median-priced home. This is an unsustainable trend. Either rates must come down a little to provide relief or home prices must come down or a combination of both.
Last Summer, in front of Congress, Fed Chair Jerome Powell was heavily criticized for creating "froth" in the housing market by purchasing mortgage-backed securities every month. What we don't know is how much "froth" the Fed wants to remove from the housing market. It's hard to imagine the Fed tightening conditions and allowing mortgage rates to increase so much that housing sees a sharp slowdown.
2.) Things Are Not All That Peachy
In addition to the inflation problem, the economy is decelerating. Economic growth is slowing. The consumer is assuming more credit card debt to pay for items and fuel costs are soaring. This is a very difficult environment for the Fed to hike rates aggressively.
Moreover, consumer sentiment and small business sentiment are down sharply with the former at 11-year lows. In this environment with high inflation and low consumer sentiment, the Fed may try to be more patient with a hike rate and wait before approaching. Seeing the 10-yr Note yield decline beneath 2.00% suggests the bond market is not worried about runaway inflation but may be looking at the notion of slower economic times ahead.
3.) Russia/Ukraine Remains Unresolved
Uncertainty around Russia and Ukraine continues. When uncertain geopolitical events take center stage, the investment community adopts a risk-off trade and buys US-denominated assets like the US Dollar, Treasuries, and even MBS.
There is a fear Russia will indeed invade Ukraine and this will send the price of oil above $100 quickly. High oil prices are a killer. It's a tax on consumers that goes uncollected. Should the Russia/Ukraine story escalate, and oil prices head higher, the Fed will have to soften its tone and be more dovish or accommodative. The opposite is true – if Russia/Ukraine comes to a political resolution, we could easily see rates pop back higher as the uncertainty is lifted. The longer this story lingers the less likely the Fed can be hawkish and hike rates.
Bottom line: The uncertainty and slowing in some sectors of our economy is giving interest rates some relief. This story could change quickly, and rates could easily creep back up and strike new multi-year highs. If you are considering a mortgage, now is a great time amidst the uncertainty and modest rate relief.