Fed Speak Shakes Markets As Rate Hikes Loom
Markets remain confused about Fed policy. The Fed voting committee was out talking up their points this week. Suggestions of a .75 bp increase in Fed funds were discussed, with some Fed members supporting this increase and others stating that this high of an increase was unnecessary. Many investors have found this situation both mystifying and frustrating. I have written previously that the Fed should have raised short-term rates sooner as well as stopped QE earlier. Many of us did not believe the Fed’s “transitory” stance on inflation as autos, homes, food, and other essential goods have increased dramatically in price over the last couple of years. Now, the Fed is way behind on inflation and is facing several challenges: a tight labor market, rising prices in oil and food, high rents, and supply chain challenges. It may be too late for the Fed to slow inflation in a timely manner absent a major drawdown in the equity markets. This drawdown would have ripple effects throughout all segments of the economy. A few more days like Thursday and Friday in the equity markets, and the wealth effect the equities market creates will be under pressure, ultimately dragging on consumer sentiment and business and consumer spending.
Interest rates are rising quickly. Banks are increasing spreads on rates. There was a recent article on the negative impact floating rate loans (which move up or down based on SOFR + margin) are having on businesses as those loan rates surge and increased debt service payments for companies. For perspective, the 2-year Treasury was ~.50% in November 2021 and is now ~2.67%. The bond market has been the first to react to Fed policy as of late after having shrugged off the idea of higher rates for many years. While the long bond has flirted with 3.000%, short-end bonds have shot up in anticipation of several rate hikes in the coming months. The equity market finally got the message this week. The 2 – 10 year Treasury spread is under .25 bp, suggesting heightened concerns about a recession sometime in late 2022 or 2023.
Mortgage rates remain elevated. The 30-year mortgage rate is now above 5.000% from most lenders. It is becoming harder to qualify borrowers as rates have risen and rates are no longer considered “cheap money.” How this affects the real estate market given the supply constraints in some markets such as Southern California is yet to be determined. It is worth noting that the combination of higher rates, the increased cost of living, and a very volatile equity market, will weigh on the minds of new home buyers. Home prices may need to come down to adjust for the many households being impacted by the pressure of added costs. There was not much to celebrate this week. It is starting to feel as if harder times are ahead of us for the coming year.