Rates Edge Higher as Inflation Expectations Rise
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.
