Morning Report: Fed Funds futures forecasting higher rates

Vital Statistics:

 LastChange
S&P futures4,481-24.2
Oil (WTI)112.921.39
10 year government bond yield 2.38%
30 year fixed rate mortgage 4.71%

Stocks are lower this morning on no real news. Bonds and MBS are flat.

Jerome Powell is speaking on a panel this morning regarding digital currencies. It shouldn’t be market-moving, but bonds are on a hair trigger after the rout over the past couple of weeks, so be aware.

New Home Sales fell 2% MOM and 6% on a YOY basis according to the Census Bureau. This was well below expectations. Rising labor and materials cost have added something like 20% to the cost of building a house. In high cost areas like California, extra regulations have increased the cost even more. This has led to an issue where it is so expensive to build starter homes that people with a starter home income cannot afford them. It is easier to build luxury homes than it is to build starter homes. Note the average sales price rose 25% YOY to $511,000.

Mortgage applications fell 8% last week as purchases fell 2% and refis fell 14%. “Rates on 30-year conforming mortgages jumped by 23 basis points last week, the largest weekly increase since March 2020. The jump in rates comes as markets moved to price in a much faster pace of rate hikes, as well as expectations of fewer MBS purchases from the Federal Reserve. With mortgage rates now at 4.5 percent, compared to rates at or below 3 percent not that long ago, it is no surprise that refinance volume has dropped by more than 50 percent compared to this time last year. MBA’s new March forecast expects mortgage rates to continue to trend higher through the course of 2022,” said Mike Fratantoni, MBA’s Senior Vice President and Chief Economist. “Purchase application volume was down slightly for the week, with a larger drop in FHA and VA purchase volume, and a small decline in conventional purchase loans. First-time homebuyers, who rely on these government programs, are increasingly challenged by both the rapid increase in home prices and higher mortgage rates. Repeat homebuyers, who are more likely to use conventional loans, benefit from the gains in home equity realized on a sale which can be used to fuel their next purchase, even with rates moving higher.”  

The Fed Funds futures continue to move into a more hawkish direction. Just one week ago, the central tendency was for the December fed funds rate to be something like 1.75% – 2.25%. Today, it is looking more like 2.25% to 2.5%. This is a massive change in sentiment.

Given that the markets are predicting such a huge increase in the Fed Funds rate, investors have to be concerned that the Fed might tip the economy into a recession, probably next year. I think with such a dramatic move, that could be a possibility. While the economy grew at a healthy clip last year, much of that was the rebound from COVID and also stimulus money.

The recession of 80-81 and 81-82 were an example of a Fed-driven recession, and at that time was the deepest slowdown since the Great Depression. Paul Volcker took the Fed funds rate from 10% to 20% in the span of a year (twice) to break the back of 1970s inflation. Below is a chart of the Fed Funds rate from 1979 – 1983. The shaded areas on the chart represent recessions. The 81-82 recession was particularly brutal for the Farm Belt and the Rust Belt.

These actions caused the economy to go into a deep recession, and really set the stage for a lot of the 1980s economic issues with farmers and oil drillers. Commodities like oil and food had a massive rally in the 1970s, which triggered plenty of losses in the banking sector, especially in the Midwest and Texas. In a case of art imitating life the bookends for the 1970s center around Texas and oil, which begins with the series Dallas and ends with pop artist Robert Rauschenberg’s glut.

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