Rates Move Lower Surprisingly As Inflation Data Picks Up

Treasury and mortgage bond yields dropped despite better than expected inflation data. This came as a surprise to some as the Fed and Treasury are doing all they can to spur inflation. They have indicated that their belief is that any inflation created by massive government spending can be controlled. While only time will tell, for the moment bond traders are believing what the Fed is saying, and that is why rates did not run away based on the hotter than then expected CPI data. 

Equity markets and alternative asset classes love low rates. Stocks had a good week. Positive economic and earning data from banks continue to support the improving economy. Housing remains on fire and in fact, there is still a major housing supply shortage which should serve as a floor to housing prices drifting lower even if rates increase over time. 

Inflating people’s savings through their investments in various retirement accounts is good for consumer psychology. We tend to spend more when we feel wealthier. During the pandemic, a lot of that spending has gone into home purchases and home improvement. Low interest rates also have put more dollars in people’s pockets which then gets spent on other activities.  

Unemployment gains were down this week. While there remain concerns about Covid-19 abroad, ongoing vaccinations in the U.S. combined with the entire population getting closer to herd immunity are unleashing animal spirits. Restaurants are bustling, people are out and about, and the airlines are reporting more booked seats on flights. The economy will boom this year as long as the virus outbreaks remain contained as people learn to enjoy life while taking precautions. As the summer approaches, unemployment should continue to fall and the economy should recover to 2019 levels toward the end of the year. 

March Jobs Report Supports Improving Economy. Bond Yields Tick Higher But Are Still Attractive.

The March 2021 jobs report was massive with 916,000 new jobs created last month. Unemployment fell to 6%. Challenges remain as long-term unemployment remains elevated and is a top concern of Fed policymakers. 

Bonds edged higher in light trading as the stock market was closed in observation of Good Friday. Bonds were also pressured this week by the announcement of a major infrastructure spending package. The plan has both pros and cons, and to date, both the bond and equity markets have responded well to the new plans to upgrade the United States which also includes corporate tax increases. As this plan makes its way through Congress, we do expect to see more volatility in the public markets expressing bond traders’ concerns about the size of the government’s balance sheet. Equity markets don’t like tax increases on corporate earnings nor the potential for higher interest rates. 

The S&P 500 surpassed the 4,000 milestone and economic activity continues to improve as vaccinations take hold and life starts to return to normal. Air travel and hotel bookings are an upswing. Consumer confidence and business confidence also are improving. 

Home sales remain strong but the overall housing market is under some pressure. Supply has been limited, and tat has driven up prices. Large traditional lenders remain very rigid in underwriting, but we’ve also seen the return of alternative loan programs including one-year tax return loans, W-2 only, and bank statement loans. Also in the mix now, CFDI programs are helping borrowers purchase or refinance debt. Rates remain attractive, fueling much activity. To help cool off speculation, Fannie Mae and Freddie Mac have added additional hits to disincentivize second home and investment home transactions to reinforce their focus on primary homeownership. The fallout of that benefits independent brokers like Insignia and our clients because we have access to lenders who are eager to lend to good borrowers at attractive rates who want to buy second homes and investment properties.

Rate Volatility Persists As Economy Gains Momentum

Bond yields moved marginally higher in the back half of the week as Wall Street worked through how to balance a strengthening economy against massive fiscal and monetary spending some experts believe will create an inflationary period last seen in the 1970s. The bond market is not totally buying the Fed’s assertion that inflation can run hot and then be tamed. Stimulus and transfer payments are in the trillions of dollars and we’re seeing tweaks to long-held mandates. This is an experiment in financial engineering the likes we have never seen domestically, nor globally. Who knows how far the Fed can push its powers to control inflation, keep rates low, while also helping the economy to create jobs. As the $3 billion infrastructure bill being passed along with potentially higher taxes, the back half of 2021 is shaping up to be very interesting.  

The worries over inflation for the everyday person are most felt through the impacts of increased costs of lumber, oil, and food prices. These costs filter up to the costs of buying a home, driving and purchasing cars, and feeding our families. CPI data continues to support the notion of minimal inflation, which may be confounding for the average American. The relatively low levels of money velocity, many millions of still unemployed or underemployed, and the near-certainty of a tax hike, are all deflationary. These are part of the reason that the Fed is not worried about inflation (yet!), and why inflation readings remain low. For now, inflation is under control and that should cap how high bond yields rise.  

All the stimulus put forth by the Fed and Congress have benefitted housing and housing-related activities. While there is much media chatter about higher interest rates, bear in mind that rates are still very low historically (remember the 1980s?) and banks remain eager to lend to qualified borrowers. There will not be a linear rise in rates, but we continue to keep an eye on Treasury yields with the 10-year trading well above 1.600%.

Rates Jump On Dovish Commentary From Fed

The bond market did not respond well to Fed Chairman Powell’s recent comments, especially when it came to letting inflation run hot. For those of us who follow the gyrations of the bond market daily, inflation has historically been the arch-enemy of bonds as higher inflation reduces the real return on bond investments. The idea of encouraging inflation to run hot and above the traditional 2% threshold is novel. Bond traders remain skeptical as the 10-year Treasury reaches levels last seen pre-pandemic. Bonds are also under pressure by the Fed’s announcement that the temporary change to the supplementary leverage ratio will run off at the end of March and also that banks will be required to lift reserve requirements. This news has added additional pressure on bond yields as banks are large holders of these instruments and now must sell them to raise capital. 

Further muddying the waters is the threat of new lockdowns in Europe and India (which creates some uncertainty on the future path of the virus and could create havoc for all investable markets)  as the virus surges in those areas and vaccinations have not been delivered in nearly the same capacity as in the U.S. Also, let’s not forget the increase in oil prices, lumber, oil, and commodities, all of which support the inflations argument, while the U.S. economy is improving. The Philly Fed Manufacturing Index also soared, which is yet another positive indicator that the economy is on the mend. 

As we have written about previously, long-duration growth/tech equities are most at risk in a rising rate environment as are speculative investments, which are priced much higher based on a very low discount rate.

We are watching how equities and bond yields react as the pandemic becomes less of a problem. An unexpected housing boom was a welcome surprise during the pandemic year and was spurred on by a rise in equities paired with low-interest rates.

However, as rates move higher, monthly mortgage payments will increase, potentially cooling both purchases and refinances. Keep in mind that the 10-year Treasury is still well below 2% and that while we are off the bottoms, interest rates are still very low historically.

Massive Stimulus Package Pushes Bond Yields Up

Interest rates are rising. This should not come as a surprise given the combination of new factors. Increased vaccinations are lighting a fire of greater economic activity and lowering unemployment. There’s the new massive $1.9 trillion stimulus package. Prices are on the rise for basic goods such as food, lumber, gasoline, and more. Assets such as equities, real estate, and Bitcoin have been soaring to record highs. But that is the type of inflation everyone loves. Consumer inflation, the everyday rise of the price of goods and services, is the greater concern. Personally, I was astonished the other day when I went to the market. Prices have certainly risen to the point where I took notice.

It is hard to square the massive government spending against extraordinary low interest rates, especially as the world recovers from Covid-19. Something will have to give and it is probable that investors will demand higher yields for buying our debt. Should rates grind higher, expect a cooling of long-duration growth stocks. It may also affect high-priced real estate, and speculative plays on crypto-currency. Perhaps many homeowners are also thinking the same thing as purchases, rates, and term refinances roar on. Especially interesting is the rise in cash-out refinances. Cashing out of your home with an interest rate below inflation is a wonderful thing as you ensure paying off debt with inflating dollars. There is a point not too far from where we are trading where higher interest rates will cool off the mortgage market, as well as, limit how high home prices can go. For the moment, with the 10-year Treasury trading at 1.61%, interest rates are still highly accommodative.   

Be prepared for a quick move to 2.000% on the 10-year Treasury if rates steady above 1.600%. We are actively watching the bond market; we do our very best to navigate borrowers during this very volatile time. The bond market sure appears to want to test Fed policy and challenge some of the exuberance in the equity market. With rates in a rising channel, for those actively looking to buy or considering refinancing, there is no time like the present. 

Good Jobs Report Moves Interest Rates Higher

Rising bond yields which continue to move higher and they touched above 1.61% after a stronger than expected February jobs report remains a major concern on Wall Street. Tech stocks that have especially benefited from 0% interest rates have gotten taken to the woodshed this week before reserving in late Friday trading. Discounting cash flows at zero percent favor high beta long-duration growth stocks. 

As mortgage originators, why do we care, you may ask? The reason is that the stock market is the wealth engine of America and for the everyday person, equity market gains are typically the down payment source for first-time home purchases, along with gift funds from parents, and step-up purchases. These major swings may hurt the spring buying season if the markets plunge lower or become increasingly volatile. 

The jobs report was a good one. While there is much more to do, beaten-down industries such as hospitality and leisure saw a marketable improvement in hiring. With vaccination deployment finding its way into all of our communities, better days are ahead. Unemployment fell to 6.20% and the labor force participation rate was 61.40%, unchanged. 

A move higher in interest rates should not be a surprise with an improving jobs picture, major fiscal stimulus on the way, and hopes for a return to normal on the horizon. Pent-up demand should lead to an upswing in GDP and put additional pressure on wages. Commodities are also signaling inflation is on the way. 

Real estate should serve as a buffer should inflation rise more than anticipated. Keeping all of this in perspective, interest rates are still accommodative. Still, keep an eye on a break-out higher to 1.75% on the 10-year Treasury as “go time” for those still not ready to purchase or who are watching the market for an optimal time to refinance. 

The bond market woke up this week as interest rates rose swiftly. The 10-year Treasury traded over 1.500%, a level the pundits believed was years away not too long ago. The rise in rates is due to an improving economy, a slowing of cases, and hospitalization from Covid-19. Also pushing bond yields higher is the massive spending out of Washington and concerns of QE forever. The current $1.9 trillion fiscal package is still being negotiated. There are some concerns that the package includes some earmarks that have nothing to do with pandemic relief. The bond market would like to see a little less money printing. If Congress can agree to trim the stimulus package, this will help rates settle and they could focus the spending on those most in need. This won’t be easy, but Congress unified for the common good would be a welcome sight. 

The Fed has stated it has the tools to manage inflation if inflation runs hotter than expected. Not everyone is convinced. Personal consumption surged in January. Inflation remains under control for the moment, but there are signs it is heating up. Key commodities such as oil, lumber, copper, and food prices are all higher than in previous months.

Extraordinarily low interest rates have boosted the housing market. It will be interesting to see how a rising rate environment will impact housing if rates continue to push higher. However, we need to keep in perspective that interest rates remain very low historically and that the reason that rates are moving higher is partially due to optimism for better days ahead. 

Mortgage Rates Rise as Covid Cases Drop; U.S. Economy Moves Toward Reopening 

Rates are edging higher as the reflation trade continues to play out. Washington is pushing hard for another stimulus package to the tune of $1.9 trillion, putting pressure on the bond market even as equities stall. Covid cases are dropping fast around the country. We hope this will lead to the beginning of a return to normalcy as vaccinations and herd immunity take hold. If the recovery continues apace, the combination of pent-up demand and consumer confidence could yield very strong economic activity. This is partly why longer-dated interest rates are rising as the markets become more optimistic about a global recovery. 

Speaking of inflation, lumber prices have been on a tear which is causing some home builders to pause or slow down building activities. When the cost of lumber and other related commodities rises, it digs into builders’ profits. It also makes new homes more expensive. This in turn puts the brake on housing, which has been a huge part of our economy in the last year. If long-dated interest rates run higher, we fully expect the Fed to step in and control the yield curve with bond purchases.  

Keep a close eye on the upward slowing yield curve. The 10-year Treasury has quietly moved up to over 1.300%, dampening mortgage refinances. As mentioned previously, the odds of rates going higher seem greater than going lower, so now is the time to apply for a loan and take advantage of this extremely accommodative mortgage rate environment while it lasts.

As the prospects of a post-lock down world take shape, rates are quietly moving higher, while remaining still historically extremely attractive. The CPI inflation numbers were lower than expected. Food prices such as soy and corn, and other commodities such as oil and lumber costs are moving up. If this trend continues, this may hurt consumption and drag down economic growth while also increasing the prospects of higher interest rates.  

Now is the time to take advantage of the exceptionally low-interest rates that were put into place to offset the downside risks of the pandemic. With Covid cases dropping, we are cheering for a return to normalcy, which will also mean a return to higher rates.  

Low interest rates have played a big part in boosting housing and auto sales, as well as boosting growth stocks and more speculative alternative assets such as Bitcoin. If rates move up too quickly, expect the Fed to intervene. The Fed has been clear that they will cheer on inflation while keeping rates low to help “juice” the economic recovery. However, we believe that the Fed will let rates rise to around 1.50% to 1.75% on the 10-year Treasury before considering yield control policy intervention. 

A downward drift in the stock market could also move rates lower. With many stock indexes globally at or above all-time highs, rates could push lower should there be a pullback.