Strength Lifts Rates
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November 15, 2024 -- When interest rates began rising some weeks ago, we wondered if economic conditions were too strong to warrant a half-point cut in rates by the Fed back in September, given solid growth in the economy and still-higher-than-target inflation. While stock markets mostly loved that cut in rates, and the subsequent one this month, bond markets seem to be expressing a different sentiment, given that long-term interest rates have actually been on the upswing since the start of October.
There were concerns that no matter which candidate won the election that budget deficits would continue to expand, requiring the government to sell more bills, notes and bonds to fill the gap. This is very likely a component of the recent increase in bond yields and mortgage rates. But something else is also driving them higher, and that is the ongoing strength of the economy and lower yet still-stubborn inflation.
While financial markets often react quite abruptly to changes in monetary policy, it takes far longer for them to actually affect the real economy. Consider someone who waits for the Fed to cut and then applies for a loan at a new, lower interest rate; it may be a couple of months before that money becomes available, and perhaps longer still before it is spent into the broader economy, increasing economic activity. Fed policy changes work with what is called a long and variable lag, so the half-point cut in September and quarter-point backup last week won't likely be fully realized until sometime well into 2025.
If economic conditions were soggy or poor, the recent cuts in rates would serve to help lift growth as time wends forward, helping to stimulate demand to a degree. But what if the economic climate were already pretty fair, or even good? Adding fuel to the growth fire could serve to keep price pressures from abating much, and this does concern investors who buy bonds. Lowering rates now should help lift economic activity in 2025, so the solid growth we're seeing now might be reasonably expected to continue, increasing concerns that inflation may not fade as hoped. From a forward-looking perspective, and presuming this is a plausible outcome, such conditions aren't likely to see the Fed in any hurry to cut rates in the future. As such, expectations for future monetary policy are changing.
In a prepared speech and in subsequent comments this week, Fed Chair Powell noted that "The economy is not sending any signals that we need to be in a hurry to lower rates," and that "Going slower, if the data tell us to go a little slower, seems like the smart thing to do," This lends some doubt that a steady stream of rate cuts should be expected, and perhaps that December may not actually be "in play" for another policy trim.
Earlier this week, federal funds futures markets suggested perhaps a 75% chance that the Fed would cut rates again by a quarter-point in December. By late Friday, those odds fell to perhaps just a 62% probability.
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While the expectation by the Fed remains that inflation will continue to cool over time, the evidence of late doesn't suggest that price pressures are behaving accordingly. This week, we got looks at inflation from the Consumer and Producer price index releases for October, and also from the changes in costs for imports and exports, too. None of them pointed to retreating price pressures.
The overall Consumer Price Index for October came in about as expected with a 0.2% increase for the month, the fourth consecutive one with a 0.2% rise. With energy costs unchanged for the month, food and service costs lifted the overall number, helping the annual rate of overall CPI inflation to rise by 2.6% over the last year, up two tenths of a percentage point from September. That said, core CPI -- a figure that excludes food and energy -- rose by 0.3% for a third consecutive month, and the annual rate held steady at 3.3%, essentially where it was in June, so there's little progress to be seen of late. Service costs continue to the culprit, and those are more difficult for the Fed to address with policy changes.
Producer prices also failed to retreat in October, with the overall measure of costs roughly upstream of consumers posting a 0.2% increase, enough to kick the annual rate of price increases here back up to 2.4%, highest since July. Core goods costs rose by 0.3% last month, bumping the annualized rate back up to 2.2% and continuing an overall firming pattern that started back in April. Service costs pushed higher by 0.3%, lifting the annual rate to 3.5%, the highest since June.
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It's not as though these are outlandish increases, or alarming, but it is true that they aren't the decreases needed for inflation to make it to the Fed's 2% goal anytime soon.
Import and export price increases likely won't help matters, either. In October, costs of imported goods rose by 0.8% even as the U.S. dollar strengthened a bit, which likely actually helped suppress the increase in import costs. It was the biggest monthly rise in import costs since April. To be fair, the increase was only enough to lift the annual rate of import inflation to +0.8% from -0.1% in September, so not especially alarming, but also not in the right direction. Goods and services headed out of the U.S. also carried 0.8% higher costs last month, but even then, our trading partners are still seeing costs 0.1% below where they were last year. Still, higher outbound costs last month may eventually turn into higher inbound costs at some point, as inflation isn't only a domestic happenstance.
While prices are firmer, there are few signs that they are acting much to deter consumers from spending, and consumer spending powers perhaps 80% of the economy. In October, retail sales rose by 0.4%, a bit stronger than forecasts called for, and sales for September were revised up by 0.5% to an 0.8% increase. This is the first back-to-back rise in retail sales since February-March. Auto sales helped lift the top-line figure, as they posted a 1.6% increase; while furniture/home goods, sporting goods and clothing were drags, all other categories of spending pushed higher for the month.
Manufacturing has been burbling along for many months, mostly at a pretty subdued level. It was a bit of a surprise, then when the Federal Reserve Bank of New York reported a significant surge in factory activity for November. The FRB/NY's local barometer rose by 43.1 points, rocketing from -11.9 in October to +31.6 for November, the highest it been since December 2021. A sub-measure tracking new orders posted a similar pop, climbing from -10.2 to +28.0, while the employment gauge remained at a positive 0.9, good enough for the first back-to-back improvements in 20 months. Prices paid eased slightly with a 1.2-point drop to 27.8, a modest figure, if one still near the top of a recent range.
If inflation isn't declining, the consumer isn't retreating and manufacturing may be showing some signs of life there's reason to think that the Fed doesn't need to continue to trim interest rates, at least to help support more near-term economic needs.
Overall industrial production declined by 0.3%, and has dipped in three of the last four months. Manufacturing output fell by 0.5% last month after a 0.3% decline in September; output by mining concerns rose by 0.3%, partially erasing a 1.9% September drop, while utility output rose by 0.7% after a 0.3% lift in the prior month. Utility output is largely affected by weather, and the onset of cooler temps in some parts of the county -- and longer nights -- saw increased energy usage last month. With the overall easing in output, the percentage of industrial production floors in active use slid to 77.1%, about as low as it has been since April 2021, although the January 2024 figure is pretty close.
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With mortgage rates rising in recent weeks, you might wonder how requests for mortgage credit managed a 0.5% increase in the week ending November 8. The answer is that the overall number is being lifted by purchase-money mortgage requests, as homebuyers look to get into homes before the holidays. Seasonal effects will soon quiet activity, likely starting as early as next week, and higher mortgage rates won't help either. They certainly aren't helping refinance activity, which shrank another 1.5% last week, making it seven weekly declines in a row. Odds don't favor a pick up in refi activity until rates again start to approach the 6% level, as they did at the end of September. That doesn't seem likely to happen anytime soon, but one can hope.
At least borrowing conditions for mortgages aren't getting any tougher. The latest Senior Loan Officer Opinion Survey from the Federal Reserve found that outside of subprime lending, underwriting conditions remained the same at greater than 90% of the banks in the Fed's quarterly poll. Only about a quarter of banks responding reported that they make any kind of subprime mortgages, and even then, some 87.5% said standards were no tougher compared to the last survey. With mortgage rates and home prices still elevated, demand for home loans was uneven; majorities of banks reported steady demand, while similar smaller fractions reported either moderately fewer or somewhat more requests for home-financing funds.
We won't get any updates on labor market conditions until after the turn of the month, as the Job Openings and Labor Turnover survey is bumped into December due to the Thanksgiving holiday, and the November employment report of course isn't due until the first Friday of the month, as usual. Until then, weekly initial claims for unemployment benefits are all we have to go on, and the trend there suggests somewhat firmer labor conditions of late. In the week ending November 9, just 217,000 new applications for assistance were filed across the country, a six-month low. Continuing claims for benefits also managed to decline a bit in the latest survey week, although they remain closer to three-year highs than not at present.
Current Adjustable Rate Mortgage (ARM) Indexes
| Index | For The Week Ending | Year Ago | |
|---|---|---|---|
| Nov 08 | Oct 11 | Nov 10 | |
| 6-Mo. TCM | 4.40% | 4.45% | 5.46% |
| 1-Yr. TCM | 4.29% | 4.22% | 5.35% |
| 3-Yr. TCM | 4.14% | 3.87% | 4.72% |
| 10-Yr. TCM | 4.32% | 4.06% | 4.59% |
| Federal Cost of Funds |
3.942% | 3.988% | 3.743% |
| 30-day SOFR (daily value) | 4.84243% | 5.02688% | 5.31995% |
| Moving Treasury Average (MTA/12-MAT) |
4.826% | 4.928% | 5.012% |
| Freddie Mac 30-yr FRM |
6.79% | 6.44% | 7.44% |
| Historical ARM Index Data | |||
As is always the case, there will be a lot more Fedspeak and a lot more data to contemplate in the coming weeks. If the trend continues as it has with solid economic growth and solid labor market conditions but little or no improvement in inflation, we'd expect the messaging to continue to add to doubts that another rate cut is coming in December. Otherwise, and if not aimed at manipulating expectations for December, it is certainly possible that the Fed might likely be looking to manage expectations regarding the path for monetary policy next year, so that when the update comes to the Summary of Economic Projections in December showing fewer cuts in 2025 than is now expected, it doesn't surprise investors.
Mr. Powell's comments this week may be the first inkling that the policy-setting committee's collective thinking about the path for rates may have started to change at the last meeting. We'll certainly find out if that's the case when the minutes of the meeting are released in a couple of weeks.
Recently and of late, the bond market is acting as though it has concerns regarding the prospects for stronger growth and changing fiscal and tax policy and the effects these may have on inflation going forward, not that it's actually vanquished. As such, the yields that most influence mortgage rates pushed higher again this week. and that will translate into higher mortgage rates again next week. As we're get some fresh updates on the housing market, we think that the average offered rate for a conforming 30-year FRM as reported by Freddie Mac will rise by perhaps 11 basis points next week, give or take a couple.
There's a lot going on as 2024 starts to wind to a close, including elections and consequential Fed decisions. What will happen to mortgage rates between now and mid-December? See what we think in our latest Two-Month Forecast for mortgage rates.
To start each year, we release our Annual Mortgage and Housing Market Outlook. In it, we take a forward look at a range of topics, including mortgage rates, Fed policy, home sales, home prices and lots more. We recently did a mid-year review to see how well market conditions met our expectations. Have a look and see how things are turning out.
For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".
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