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Highest Rates In Nearly 3 Years Ahead of Next Week’s Fed Hike

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The Fed will raise key policy rates for the first time since 2018 next week, Mortgage rates Not waiting to move up. By the end of this week, they were as high as they were in almost three years.

The mortgage market has been on the move for a long time, worrying about rate hikes next week. That was a natural conclusion by mid-January. Rather than that Mortgage rates At the fastest pace since 2013, we have addressed the worst of the problems combined to boost fixed rates on average 30 years.

2013 actually shares an important element with our perfect storm. Fed bond purchase.

In response to the 2008 financial crisis, the Fed announced the first episode of large-scale bond purchases aimed at stopping deflation and boosting economic growth (technically quantitative easing or abbreviated). Also known as QE).

QE tends to put significant downward pressure on interest rates at firstHowever, after that, the rate is logically higher. Interest rate spikes are particularly sharp if the Fed reports a reduction in quantitative easing policies that the market did not fully expect. That happened in 2013 when the Fed officially announced its intention to taper bond purchases. The resulting rate spike is thus “Tapered tram.. “

Fast forward to early 2022 And the market has endured similar turmoil. As in 2013, traders knew that the Fed would never buy bonds. In fact, the Fed had already announced a taper in late 2021, but in January it accelerated the pace of taper and surprised the market. Insulting the injuries, they also reiterated their desire to hold only the Treasury in their bond purchase portfolio, rather than the more directly profitable mortgage-backed securities. Mortgage rates..

Tapering means reducing the amount of bonds the Fed buys. When the Fed actually reduces bond holdings, it is known as “normalization.” This was another complex factor in interest rates in early 2022, as the Fed promised a much faster transition from tapering to normalization (months instead of years).

These policy shifts alone were sufficient for the mortgage market to underperform the broader bond market. Than any other time Since the 2008 financial crisis (the graph below measures this decline in performance). The only exception is March 2020, but for some major reason the month of market movement should only be compared to itself.

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Performance degradation is one thing, but what if the “wider bond market” is doing well? If Treasury yields (benchmarks in the broader bond markets) are declining, have interest rates really been unable to stabilize?

completely! Unfortunately, the Treasury yields haven’t declined.They just had them Worst week since 2016 (Repeat, March 2020 is not included in the comparison). Sure, it wouldn’t have been so sudden if there hadn’t been any volatile movement towards low interest rates from the Russian / Ukraine war last week, but Treasury yields are still approaching their highest levels since mid-2019. ..

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In essence, the market will soon be priced with the 2022 aggressive Fed rate hike campaign, even if the usual 25 basis point (also known as 0.25% or 25bps) Fed rate hike is seen at next week’s meeting. came back.

The following chart shows how market expectations for a Fed rate hike have changed in recent months, both at next week’s meeting and throughout 2022.

  • The closer the orange / blue line is to one of the dotted level lines, the more the market predicts that level of federal funds rate. In other words, in mid-February, the market thought it was likely to raise rates by 50bp.
  • Remember that the Fed sets interest rates in 25bp increments. The current federal funds rate target is 0.00-0.25% (so .25-.50% requires a 25bp rate hike).

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Why did expectations for rate hikes return to their recent highs despite Ukraine (that is, the blue line is at the lowest)? In a word, inflation.. Indeed, without the rapid rise in inflation expectations, 10-year yields would still have fallen in the 1.7% range.

The following chart shows the actual 10-year Treasury yield and Inflation-adjusted yield.. They are so far apart that they cannot display meaningful details on the shared axis, so they are overlaid on separate axes to show the correlation. If inflation expectations are stable, these two lines are almost perfectly correlated. In this case, the fact that the blue line jumps away from the green line means that the surge in bond yields is almost exclusively caused by inflation expectations.

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Is this due to Ukraine or was the ball already in motion?

Inflation expectations were rising sharply as the market bounced sharply from the first pandemic-related shock, but before Russia invaded Ukraine, it did a better flat job. The following graph shows exactly the same line as the previous graph, but over the last few years.

20220311 nl4.png

Why is the Ukrainian War causing inflation?

For a variety of reasons, as a result of the Ukrainian War, some commodities are experiencing unprecedented price increases. Oil price It has received most of the attention, and of course it is. As long as the world relies on oil to power almost everything, oil is intertwined with almost all costs.Prices were already steadily rising as production struggled to keep up with the increase in demand from the pandemic, but Russia’s invasion of Ukraine sent oil. Scream another $ 20 / barrel higher..

20220311 nl6.png

What do inflation and oil prices have in common?

The same orange line for “implicit inflation” on the same chart as oil prices is:

20220311 NL5.png

Conclusion, Now everything depends on inflation. It was already true before Ukraine, but now it is painfully true. Inflation is an important Fed consideration in making changes that push up interest rates. From here, the market will pay more attention to oil prices and inflation indicators. They will listen enthusiastically as Fed Chair Powell will comment next week on whether the Fed’s reaction function could change again in the light of rising commodity prices.

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