All Things in Moderation

Vital Statistics:

	Last	Change
S&P futures	4,329	-23.2
Oil (WTI)	101.32	6.59
10 year government bond yield		2.16%
30 year fixed rate mortgage		4.52%

Stocks are lower this morning after the Fed raised rates yesterday. Bonds and MBS are up.

The Fed hiked the Fed funds rate 25 basis points, and announced that it would begin shrinking its balance sheet “at a coming meeting.” The dot plot was moved up markedly, and pretty much caught up with the Fed Funds futures. The comparison between December and March is below:

Chart: Dot Plot Comparison

Two thinks to note here. First, the consensus is that the Fed Funds rate will be between 1.75% and 2.25% by the end of the year, and second the Fed expects to have rates above the long-term expected rate for 2023 and 2024. Much of this will be determined by the path of inflation going forward.

The economic forecasts were tweaked, with the 2022 GDP growth forecast trimmed to 2.8% from 4% in December and the inflation rate increased from 2.6% to 4.3%. The Fed Funds estimate for 2023 and 2024 were bumped up as well.

The press conference wasn’t that interesting, however Powell stressed that the effects of the war in Ukraine were highly uncertain and were likely to both push up inflation and dampen economic growth. That said, 2.8% GDP growth is normally a pretty solid number, so it isn’t like the Fed sees that much of a recession risk. The questions largely centered around whether the Fed was behind the curve, and also around the fact that real (i.e. inflation-adjusted) interest rates are still highly negative.

Mortgage backed securities and Treasuries were sold off in the aftermath of the announcement, although Treasuries clawed their way back. Mortgage backed securities were under pressure as the market ponders what will happen to prices when the Fed begins to unload its holdings of MBS. On the plus side, refi volume is drying up, so there will be less supply from mortgage banks, but the Fed has a lot of paper to go.

Treasuries and MBS are clawing their way back this morning, with yields falling marginally. Probably a case of buy the rumor, sell the fact.

Housing starts came in at 1.77 million, which was a touch above expectations, and building permits rose to 1.86 million. Housing starts are up 22% compared to a year ago. Housing construction has been the missing element from the economy ever since the 2006 housing bubble, and there is tremendous pent-up demand for construction. This is this sort of thing that could feed the economy for years. The problem, of course is affordability, and shortages of materials and skilled labor.

Separately, builder confidence is slipping, according to the NAHB / Wells Fargo Housing Market Index. “Builders are reporting growing concerns that increasing construction costs—up 20% over the last 12 months—and expected higher interest rates connected to tightening monetary policy will price prospective home buyers out of the market,” said NAHB Chief Economist Robert Dietz. “While low existing inventory and favorable demographics are supporting demand, the impact of elevated inflation and expected higher interest rates suggests caution for the second half of 2022.”

Industrial production rose 0.5% MOM and manufacturing production increased 1.2%. Capacity Utilization rose to 77.3%. This is another long-term trend to watch. Companies are bringing back manufacturing to the United States as the wage gap between the developing nations and the US is shrinking, and companies have realized the vulnerabilities of extended supply chains. This will take years to play out, but the offshoring / outsourcing megatrend of the last 40 years might be played out.

Filed under: Economy |