Morning Report: The Fed signals a pause in rate hikes

Vital Statistics:

Happy Dave Brubeck Day. Stocks are lower this morning as regional bank fears continue to simmer. Bonds and MBS are up.

As expected, the FOMC hiked the Fed Funds rate by 25 basis points and signaled they are ready to pause. It removed language referring to further tightening of policy. During the press conference, Powell pushed back on the idea that the Fed was ready to cut rates. If you look strictly at the dual mandate, that makes sense. On a scale of 1-10, the labor market is at a 9.8, while inflation remains way too high. He acknowledged that it will take a while to get us down to 2% inflation, but emphasized the Fed isn’t willing to relax that target to something like 3%. FWIW, inflation averaged about 3% from 1985 – 2000 and I think most people would regard that time period as pretty comfortable economically.

The bond market was already strong due to the regional bank situation, with PacWest falling 50%, so there wasn’t much reaction to the new language on the long end, although the 2 year did rally on the announcement. The Fed Funds futures are now predicting the Fed will do nothing at the June meeting, and there is a 50-50 chance of a rate cut at the July meeting. The futures are not factoring in any more rate hikes, and they see 75 basis points of easing by the end of the year.

Nonfarm productivity fell 2.7% in the first quarter as output rose 0.2% and hours worked increased 3%. Compared to a year ago, productivity fell 0.9%. Unit labor costs rose 6.3%. Productivity is an inflation-killer, so this is bad news for the Fed.

The regional banks are getting slugged again today, with PacWest down another 40%, and First Horizon down big after its merger with TD bank is terminated. Western Alliance is down despite a press release that updated the markets on its deposit situation. Zions is down as well. If anything will push the Fed to cut rates, this is going to be the catalyst.

Job cuts in April fell 25% month-over-month to 66.995. They are still triple the number they were a year ago. Retail led, along with technology. Separately, initial jobless claims rose to 242k.

Mortgage applications decreased last week as purchases fell 2% and refis fell 1%. “Mortgage applications decreased last week, despite rates declining slightly for the first time in three weeks. The 30-year fixed rate decreased five basis points to 6.5 percent, which is still 114 basis points higher than a year ago,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Elevated rates continue to both impact homebuyer affordability and weaken demand for refinancing. Home purchase activity has been very sensitive to rates and local market trends, including the very low supply of existing-home inventory. However, newly constructed homes account for a growing share of inventory, giving more options for prospective buyers. The jumbo-conforming spread continues to narrow, an indication that there is reduced lender appetite for jumbo loans following the recent turmoil in the banking sector and heightened concerns about liquidity. The spread was 13 basis points last week, after being as wide as 64 basis points in November 2022.”

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