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Reconciling Recently Irrational Rate Movement (It’s Actually Rational!)

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market and mortgage interest rate is currently trying to orchestrate a big narrative that has explained most of the movement in 2022. In one corner is inflation and the forces trying to fight it. Another is the economic impact from that fight.

Inflation was the main reason interest rates soared in the first half of the year.Inflation is bad As for interest rates per se, it gets worse when the Fed pushes aggressively to tighten monetary policy.

In other words, the Fed is one of them. Power trying to fight inflation. This is done by raising short-term interest rates directly and by making policy changes that indirectly raise long-term interest rates.

It may seem like cruel punishment The Fed’s rationale for pushing rates up when inflation is already making prices higher is that it’s better than the alternatives. We want to keep inflation under control.

The Federal Reserve is completely transparent in saying that fighting inflation will hurt the economy. After all, this is the idea.demand“Because of the economic aspect”supplyThen, when the balance is restored, the Fed will ease policy and consumers will be able to return to normal economic activity without suffering decades of high inflation.

All of inflation, and the expected impact of the Fed’s anti-inflation measures, peaked in June. Interest rates jumped to his highest level since 2008. The market expected such a restrictive environment to harden. negative The economic momentum that was already apparent in some reports. Some reports from July showed just that, and before we knew it, mortgage rates were trending downward.

At that time, we thought that interest rates were Landscape orientation, volatilization range This is on the expectation that the Fed wants inflation data to settle for several months before declaring victory and starting to discuss easing monetary policy. However, economic data in late July were weak enough that the market feared an excessive correction. “Recession” was an inevitable word in news headlines.

What a difference these two weeks have made!Be in trouble weak Economic data generally replaced by amazing PowerLast week’s jobs report played a key role in that turn, but it wasn’t the only report suggesting economic resilience. Just today, his preliminary August figures from the Consumer Sentiment Survey have beaten expectations significantly. Considering the same report last month, the noticeable changes raised concerns.

Certainly economic data has had an impact, pushing interest rates higher in general, but the star of the show this week has always been Wednesday’s Consumer Price Index (CPI). Or so I thought.

The Consumer Price Index was the first of two significant inflation reports released by the US government and was at the center of the biggest swings in interest rates in 2022. This week’s announcement marks the first decisive drop of the year. Part of “The long-awaited drop.

The decline was most pronounced in month-over-month ‘headline’ CPI. This refers to all prices counted in the report, but “core” CPI excludes food and energy prices.

Headline inflation may have been 0.0% m/m, but the Fed is targeting core inflation in the range of 2-2.5% y/y. Let’s say we’re not there yet.

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Still, the flattening of the orange line in the chart above is good news for rates. A day later, it was joined by a similar decline in inflation at the wholesale level seen in the Producer Price Index (PPI).In fact, headline prices actually fell in that report.

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Again, falling inflation is good About fees. In fact, it seems that the calculation was valid on Wednesday morning. Bond yields fell sharply after the CPI was released, but the improvement was short-lived.

Here’s the problem: low result of inflation high rate?

That is very tricky Because the fall in inflation was in the wrong place at the wrong time. Remember how the “flat volatility range” was expected to take hold after interest rates spiked in early 2022? Multiple Fed speakers over the past two weeks said this was a very good call. It turns out. They have banded together to remind the market that they must not get ahead of themselves in hopes of friendly Fed policy and that a significant improvement in inflation is needed before they can even consider such a thing. I came

At the same time that the Fed’s speakers were delivering a sober message, bond traders were already feeling that interest rates were moving from peak to trough a bit too quickly. The 10-year yield shows psychology with a horizontal line that roughly shows the lateral range.

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The Fed’s comments also high bar Change your outlook for rate hikes in the near term. Based on traders betting on the Fed Funds Rate in the futures market, we know the market agrees with the Fed. The next three charts show rate hike expectations for next month, December 2022 and next June.

Expectations for a September rate hike surged in June and July after CPI data showed higher inflation. Things calmed down in late July as economic indicators were weak. It then rose slightly after last week’s jobs report and fell by the same amount after his CPI this week.

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What we can see from the chart above is that the market is just very surprised that inflation keeps moving. taller than June and July. An eventual change (seen in this week’s data) was expected, but an improvement in economic data was less certain. With the outlook for short-term interest rates more fixed, the market is instead relying on economic data to shape its outlook for long-term interest rates.

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By the time we turn to forecasts for the June 2023 meeting, we’ll find that the CPI has fallen by the wayside and its importance has been completely supplanted by economic data.

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It’s hard to tell from three separate charts that the forecast for June 2023 is much more volatile. The following graph shows a comparison with the previous three set on the same axis. Think of the low point of the green line in late July as the market saying that the Fed will have to start cutting rates by the middle of next year as the economy slows so much. This makes data-driven a more logical bounce back in early August.

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What does all of the above have to do with the counterintuitive move in mortgage rates? Simply put, long-term rates such as 10-year yields and mortgages have more in common with the Fed’s long-term rate expectations. I have.

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The chart above has hourly intervals to show the correlation between US Treasuries and Fed rate hike expectations. The following chart is displayed daily to show the correlation between mortgage interest rates and government bonds.

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As for the formation of interest rate momentum, next week will be even more informative at a time when economic data is pulling the reins from inflation data. Wednesday’s retail sales are the most important report, but there is other data (mostly house-specific) every other day except Friday.

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