Last Week in Review: Rising Rates and New Home Sales
August has not been kind to bonds and interest rates. Even though the Federal Reserve did not hold a meeting in August and is not slated to raise rates again until the end of September, long-term rates moved higher. Let's break down what happened and look into the week ahead.
Rate Volatility and Uncertainty Continues
Mortgage-backed securities (MBS), where home loan rates are derived, have declined since the beginning of August, losing nearly 200 bps through this week. As prices decline, rates move higher. This drop in MBS prices pushed home loan rates higher by .50% and more.
The continued volatility and uncertainty centered around whether inflation has peaked, if the labor market is softening and what the Fed is going to do about it...hike rates and shrink their balance sheet.
On the balance sheet reduction front, come September, the Fed is slated to double the current caps to $95B. What does this mean? Starting next month, the first $60B in Treasuries and $35B in MBS proceeds the Fed receives through bond maturing, refinance or purchase activity will be given back to the Treasury rather than reinvested in bonds. This is how the Fed will shrink the balance sheet by $95B per month.
It is worth noting that balance sheet reduction or Quantitative Tightening is not tested and there is no formula as to its impact on the economy, so the Fed is going to proceed with this enhanced $95B monthly runoff until something weird happens in the financial markets just like it did in their previous attempt to shrink the balance sheet back in 2018. This underlying uncertainty as our economy slows is also unnerving for both stocks and bonds.
Yield Curve Remains Inverted
The 2-year yield (3.34%) has been higher than the 10-year (3.07%) for weeks and hit nearly .50% which is the widest inversion in this century. Every time this inversion has emerged over the last 50 years it accurately preceded a recession. We are either in a recession or at its doorstep and future readings will tell.
New Home Sales Recession
New Home Sales in July plummeted to an annual rate of 511,000, representing a year-over-year decline of 29.6%. The supply of new homes available to sell increased to a 10.9-month supply; the largest since March 2009. August's reading could also be bad considering rates spiked sharply.
The Fed was looking to remove froth from housing, and it appears that goal has been accomplished. The recent weakness in housing was necessary and healthy for the long-term market. The pace at which home prices were rising was unsustainable.
As far as new home sales go, builders are going to proceed very slowly, if at all, on new projects until inflation, rates, and the 10.9 month supply ease. This soft patch in new home sales provides a great opportunity for a buyer as new incentives are emerging around the country to help move inventory.
Oil Back Above $90 a Barrel
Oil, the main input in headline inflation is back on the rise, having eclipsed $94.00 a barrel. If inflation continues higher it will embolden the Fed to increase rates further. But remember, the Fed controls short-term rates. The Treasury market and long-term rates tell the Fed what to do and with the yield curve inverted, it is saying the economy is slowing and we can't afford much higher rates.
Bottom line: Home loan rate improvement has stalled of late as financial markets try to figure out whether inflation has peaked and how far the Fed will go with rate hikes. Until the next Fed Meeting, we should expect more uncertainty and volatility. Meantime, there are many opportunities in housing as we see increased inventory and price reductions.