All Things in Moderation

Vital Statistics:

	Last	Change
S&P futures	3,866	17.55
Oil (WTI)	101.68	3.14
10 year government bond yield		2.93%
30 year fixed rate mortgage		5.69%

Stocks are higher this morning on no real news. Bonds and MBS are down.

The FOMC minutes were released yesterday at noon. The takeaway is that the Fed is worried most about inflationary expectations becoming entrenched in the economy and is willing to cause a recession to defeat inflation. The time period between the May and June meeting had two big data points: the consumer price index which showed headline inflation at 8.7% and the University of Michigan Consumer Sentiment Index which showed inflationary expectations rising.

Inflationary expectations are critical because they have a self-fulfilling aspect to them. Vendors begin to build them into contracts, employees (especially those that are represented by collective bargaining) negotiate raises into contracts, and consumers / businesses begin to hoard materials in anticipation of future price increases.

The Fed has two vehicles to measure inflationary expectations. The first is consumer sentiment surveys like the University of Michigan and the second is the differential between Treasury Inflation Protected Securities (TIPS) and Treasuries. These market-based measures of inflation so far are still behaving, which gives the Fed some comfort. That said, the University of Michigan report along with the super-tight labor market gives the Fed the leeway to act aggressively. The self-reinforcing aspect of inflationary expectations means that the cost of bringing down inflation now (in terms of growth) are much lower than it will be when these expectations become entrenched. Don’t forget the 1981-1982 recession was the worst since the Great Depression and the Fed took up the Fed Funds rate into the mid-teens to defeat inflation. This is what the Fed is trying to avoid.

In terms of rate hikes, the view that 75 basis points was necessary was almost unanimous, with one participant wanting to hike 50 at this meeting and then 75 in July.

Sprout Mortgage is shutting down, the latest casualty in the mortgage business. So far, the company hasn’t publicly commented, but this was apparently announced on a conference call. There is no word on what Sprout will do with loans in the pipeline and the company isn’t responding to media requests for comment. Separately, Wells announced more layoffs. It will be interesting to hear from the banks next week when they announce earnings. Wells had telegraphed that origination income will be down 50% compared to Q1.

In other economic data, initial jobless claims rose to 235k last week. Meanwhile, outplacement firm Challenger Gray and Christmas reported that announced job cuts rose to 32,517 from 20,712 during the same month last year. The automotive sector bore the brunt of most of the changes, as shortages and high prices are depressing business. Health care / products is also laying off workers as the COVID-19 pandemic hiring spree reverses.

So far the labor market remains tight, but cracks are beginning to show in the foundation. I keep saying this, but it bears repeating: the rate hikes from earlier this year won’t begin to impact the economy until late this year.

Finally, there is no ADP report this month as they are retooling their methodology. There has been too much of a difference between the ADP report and the BLS’s Employment Situation Report so they are reworking their models.

Filed under: Economy | 53 Comments »