All Things in Moderation

Vital Statistics:

	Last	Change
S&P futures	4,314	-75.2
Oil (WTI)	83.61	-1.53
10 year government bond yield		1.72%
30 year fixed rate mortgage		3.74%

Stocks are lower this morning as we head into Fed Week. Bonds and MBS are up.

The movement in asset prices has been interesting. Stocks are getting clobbered, although the stock market was up big last year and earnings expectations are sky-high. Commodities in general are up, especially oil and lumber. Bitcoin has been cut in half, while gold is holding up. There are two things going on, IMO: the first is Ukraine and the threat of military action. The second is the Fed taking away the punchbowl.

Global bond yields have been falling over the past few days, with the German Bund now negative 10 basis points after briefly trading with a positive yield. If the markets were really worried about war, the dollar would be rising, and it is more or less in the same place it has been. It is possible the US gets involved in Ukraine, but I doubt it – American voters are pretty war-weary at this point.

Ultimately, this market behavior is being driven by the Fed. Rates are going to rise, stock market multiples are going to shrink, and short-term money market funds will be able to compete with other asset classes for capital. The big question is what happens to real estate prices. Nearly everyone thinks home price appreciation is going to slow. That said, the supply and demand situation is so unbalanced that I can’t see a decline in home prices unless long-term interest rates really rise, and we get a massive homebuilding boom.

The big question is whether the economic strength we have been seeing is sustainable. If it was driven entirely by stimulus, then we should see a weakening in the numbers in the next few months. This would take some pressure off the Fed, although the inflation numbers are going to be elevated over the next year, which is a function of last year’s growth in home prices. If this is the case, we have might be looking at that 70s show, where we go back and forth between inflation and recessions.

The Fed meets on Tuesday and Wednesday. No changes are expected in rates, however the markets will be looking closely for clues about how the Fed will go about reducing the size of its balance sheet. The last time they tried, it created problems in the repo market. We’ll see if they can prevent unintended consequences this time around.

The upcoming week has a lot of important data, with home prices, the initial estimate for 4th quarter GDP (the range is huge here: 3.7% to 7.1%), new home sales, personal incomes and outlays, and consumer sentiment.

Speaking of GDP estimates, the Chicago Fed National Activity Index declined in December, which indicates the economy grew below trend. This index is a meta-index of a bunch of different indicators, so it is not really market-moving, however it is useful for getting a general sense of how the economy is performing.

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