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After taking the Fed’s rate hike on Wednesday in stride, investors lost their appetite for bonds on Thursday in a selloff that pushed mortgage rates to new 2022 highs.
Bond markets recovered on Friday, with yields on 10-year treasury bills, a barometer of mortgage rates, falling from a high of 3.77%. Strong investor demand for bonds and mortgage-backed securities is driving up their prices and lowering yields.
But Friday’s renewed demand for bonds could prove short-lived, if prompted by a transitory flight to safety by investors. Former Dallas Fed President Richard Fisher told CNBC that he expects 10-year bond yields to reach 4% by the end of the year.
Shares fell on Friday on fears that, as the war in Ukraine drags on, ongoing moves by the Fed and other central banks to raise short-term interest rates to fight inflation could ultimately lead to a recession.
“The market thinks the economy is going to slow faster than the Fed,” said Mark Cabana, head of US rates strategy at Bank of America. Told the New York Times.
Mortgage rates reach new highs in 2022
Optimal Blue Mortgage Market Indices, which are updated daily, showed 30-year fixed-rate mortgage rates hit a new 2022 high of 6.4% on Thursday.
While 30-year fixed mortgage rates jumped above 6% in June on similar fears, by August 1 they had fallen to 5.26% as investors in mortgage-backed securities bet that the inflation would decline and the Fed would slow the pace of interest rate hikes.
But mortgage rates and Treasury yields have risen steadily since Aug. 1, as Fed policymakers continued to telegraph their determination to fight inflation “hard” even if it causes “a bit of pain for investors.” households and businesses”.
Coming out of their last two-day meeting this week, Fed policymakers made it clear they were ready to continue raising the short-term federal funds rate to a target of 4.4% by the end of this year and to maintain high rates. until inflation comes down.
Fannie Mae economists expect a fourth hike of 75 basis points in November and a 50 basis point hike in December to hit the federal funds rate target.
“This is above our most recent rate expectations, although we have long predicted that the Fed would need to tighten monetary policy aggressively to fight inflation and in doing so would likely push the economy into a recession. in 2023,” Fannie Mae economist Nathaniel Drake said in a memo friday.
While the treasury and mortgage debt markets took the news in stride on Wednesday, a strong sell-off in bond markets sent treasury yields and mortgage rates higher on Thursday.
While the central banks of Britain, Sweden, Switzerland and Norway also hiked rates, “this is the Fed’s signal that it expects high US rates to last until in 2023 that triggered the last sell-off”. Reuters reported.
At a press conference on Wednesday, Fed Chairman Jerome Powell seemed determined to quell speculation that the Fed would soon ease rates, noting that the Fed does not see inflation returning to its target of 2% until 2025.
“So far, there’s only modest evidence that the labor market is cooling,” Powell said. “Job offers are down a bit. Resignations are far from their historic highs. There are signs that wage measures could flatten. Payroll gains have moderated, but not by much.
In a note to clients on Friday, Pantheon Macroeconomics chief economist Ian Shepherdson said his firm’s forecast “suggests the economy will not plunge into recession.”
But Shepherdson said the fact remains “the Fed clearly wants the labor market to weaken quite significantly. What is not clear to us is why. We believe inflation will dip over the next year as margins compress, in the wake of the rapid normalization of supply chains, to the point that an understatement of the core PCE [personal consumption expenditures] inflation next summer is a real possibility.
Rates should not fall
Source: Fannie Mae Accommodation forecast.
Fannie Mae economists take the Fed at its word that it is not backing down on monetary policy tightening.
In a August ForecastFannie Mae economists predicted 30-year fixed-rate mortgage rates likely peaked in the second quarter at 5.2% and would decline for five straight quarters to average 4.4% in the second quarter. second half of 2023.
But in their September forecast, economists at Fannie Mae said they now see mortgage rates peaking at 5.7% in the last quarter of this year and the first quarter of 2023, before falling slightly to 5, 5% by the last three months of next year.
If there was a silver lining for mortgage rates to come out of this week’s Fed meeting, it was that Powell said there were no plans to ramp up “quantitative tightening” to reduce the central bank balance sheet of nearly $9 trillion.
Fed balance sheet
Assets held by the Federal Reserve through quantitative easing purchases now include $5.67 trillion in long-term Treasuries and $2.71 trillion in mortgage-backed securities. Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis.
The Fed is currently losing $60 billion in Treasuries and $35 billion in mortgage debt every month by letting expiring assets go off the books. In the past, Fed policymakers have said they would also consider selling Treasuries and mortgage debt if necessary to accelerate the tightening, which would put upward pressure on mortgage rates.
“It’s not something we’re looking at right now and not something I expect to be looking at in the near term,” Powell said Wednesday. “It’s something we will turn to, but the time to turn to it is not near.”
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Email Matt Carter