Is a Fed rate cut all but guaranteed this year, thanks to low inflation?

March 2021 FOMC Meeting: Fed Isn’t Sweating Inflation Expectations

Is a Fed rate cut all but guaranteed this year, thanks to low inflation?

When the Federal Reserve Open Markets Committee (FOMC) last met, President Biden had just been sworn in and Congress had only just begun debating his $1.9 trillion stimulus proposal. Vaccinations were progressing haltingly, and more than 150,000 people a day were still getting Covid-19. The mood was somber.

Much has changed in the intervening seven weeks. New Covid-19 infections have fallen by two-thirds, more than a few states are ending economic lockdowns and tens of millions Americans have received vaccinations—especially the most vulnerable.

The passage of the American Rescue Plan and the brightening economic outlook are sharpening concerns about inflation, at least among professional investors. More and more observers expect the economy to come roaring back in 2021, and that might mean higher prices.

Unsurprisingly, the Fed is still playing it cool. Today, it left the federal funds rate right where it’s been since March 15, 2020: 0.00% to 0.25%. But how much longer the FOMC will hold on to their easy money stance has become a near obsession for markets and investors.

The U.S. Economy Is Healing

Today’s Fed meeting wraps up one of the more remarkable 12-month periods in the central bank’s history.

One year ago, the FOMC had held its second emergency meeting inside of a month, cut the fed funds rate to 0.00% to 0.25% and restarted quantitative easing (QE) to prop up the bond market. Since then, the Fed has added $3.5 trillion to its already bulging balance sheet, and it’s unly to raise rates again until 2023.

These emergency policies, together with more than $5 trillion in stimulus spending by the federal government, have helped the U.S. economy heal much more quickly than many expected. And thanks to thousands in direct stimulus and unemployment insurance payments, many Americans actually increased their savings over the past year.

All that cash sitting in the bank accounts is just waiting to be spent, and most American households just received $1,400 per person in stimulus checks.

With post-Covid-19 normality getting closer and closer, the U.S. economic recovery is underway. After peaking at almost 15% in April 2020, the unemployment rate declined to 6.2% in February 2021.

The Fed sees U.S. GDP growing 6.5% for 2021, according to its latest Summary of Economic Projects (SEP) forecast, up from an estimate of 4.2% almost three months ago.

It also sees the unemployment rate dropped to 4.5%.

Whereas the recovery from the Great Recession proved to be a slog, the Covid recovery is looking very bright.

Wall Street’s Inflation Worries

The Federal Reserve, as Fed Chair Jerome Powell keeps reminding the world everytime he speaks, has two jobs: maximize employment and keep prices stable.

Fed QE and Congress’s stimulus aid was intended to help keep Americans and business afloat until economic life returned to normal. Now that recovery is coming, investors are seriously worried about the Fed’s ability to keep prices stable.

One way to gauge this concern is the 10-year breakeven inflation rate, which is basically the difference between two 10-year Treasury Notes—one indexed for inflation and one that isn’t. This metric tells you where investors think inflation is going over the next decade.

Right now, the 10-year breakeven inflation rate is 2.3%, which is slightly higher than where it was in the summer of 2018, when the Fed was still raising interest rates. More to the point, it’s also the highest it’s been, period, since 2014. At the start of 2020, it was right around 2%.

On the one hand, investors are correct in expecting inflation to rise.

Not only is the federal government spending vast amounts of money, but Powell himself said the Fed will tolerate inflation above its 2% target for a period of time before raising interest rates.

One of the reasons the Fed welcomes higher prices is that inflation growth was well below target since the Great Recession—and low inflation is not always a good thing.

But inflation is a word that strikes fear into the hearts of rich Wall Street investors. For some, the words “high inflation” provoke memories of the terrible era of the late 1970s and early ‘80s, when the economy was stuck in neutral and inflation grew control, a state of affairs called stagflation.

The Fed Ain’t Worried—Should You Be?

Wall Street’s inflation concerns may be overblown. While the labor market has improved dramatically since the darkest depths of the pandemic, tens of millions are still work today. Meanwhile, many of the other advanced economies around the globe are also struggling to recover from the crisis.

The Fed believes inflation, according to its preferred gauge, will rise 2.4% this year, and so-called core inflation, which strips out volatile food and energy prices, will gain only 2.2%.

“The combination of slower growth in many of America’s major trading partners, remaining slack in the labor market and contained expectations of future inflation—helped by the Fed’s previous efforts to break a coercive inflationary spiral—should prevent inflation from becoming unbridled over the next few years,” said a trio of Wells Fargo economists in a recent note.

Nevertheless, Fed watchers will be on the lookout for any sign that the central bank may tighten, even subtly, its money spigot.

*  *  *  *  *

You’d think the FOMC)would be meeting under happier circumstances this month.

Covid-19 hospitalizations have fallen off a cliff, millions of Americans are getting vaccinated every day and consumers have kept spending thanks in part to the $900 billion relief package passed late last year. Economists believe that after a rough 2020, the economy will experience a boom in 2021 the s of which has not been seen for years.

Yet investors are acting skittish. Stocks are off recent all-time highs, and tech companies in particular have gotten hammered. The yield on the 10-year Treasury has risen in recent weeks, showing less demand for fixed income (bond prices and yields have an inverse relationship).

Here’s the culprit: Everyone is suddenly worried about inflation, which has been muted since the end of the Great Recession more than a decade ago. Well-heeled Wall Street investors are worried that a roaring economic comeback coupled with almost $2 trillion in Covid-19 relief spending will cause prices to soar, they did in the 1970s.

Federal Reserve Chair Jay Powell has tried to pump the brakes on this narrative, to no avail, saying again and again that the economy has so much ground to make up that inflation shouldn’t be anybody’s main concern.

“We’re still a long way from our goals of maximum employment and inflation averaging 2% over time,” Powell said in an interview at The Wall Street Journal Jobs Summit on March 4.

Professional investors can be a delicate lot, though. They want calming words of encouragement from Chair Powell before they can sleep soundly at night.

What Is the Bond Market Telling Us?

Bond yields have been rising for much of the past two months. For instance, the yield on the 10-year Treasury Note was:

  • 0.917% on January 4
  • 1.148% on February 4
  • 1.552% on March 4

The fact that investors are shedding fixed income assets shouldn’t be particularly surprising.

President Joe Biden recently announced that there would be enough vaccines to inoculate all U.S. adults by the end of May, roughly two months earlier than expected. Congressional Democrats are poised to pass a $1.9 trillion relief package that comes with $400 per week in extra unemployment insurance, $1,400 stimulus checks for many adults and a bigger child tax credit.

The labor market went a bit sideways in the winter months, it’s true, thanks to rising Covid levels and redoubled state lockdowns, but the most recent report showed signs of progress. After shedding almost 230,000 jobs in December, employers added back almost 50,000 in January. That number will ly improve in February, with Covid cases falling dramatically.

Tie it all together, and you see an economy ready to return to normal, with the bond market adjusting accordingly.

“Bond yields are rising right now because the market is pricing in the reopening of the economy for the post-Covid-19 world and accelerating economic growth,” said Richard Saperstein, chief investment officer for New York City-based wealth advisor firm Treasury Partners.

Tech Stocks Are Getting Crushed

And yet some market participants are getting jittery. The S&P 500 traded at an all-time high of nearly 4,000 in the middle of February, but has since dropped to less than 3,800 as of early March.

Tech stocks have borne the brunt of the sell-off. Electric car maker Tesla Inc (TSLA), for instance, dropped from more than $850 a share in early February to about $620 a month later, a massive decline of about 25%. Nasdaq, the tech-heavy stock exchange, was down 10% from its high.

This is the opposite of last year, when bond yields crashed, tech stocks roared and Tesla became the world’s most valuable car company by a mile.

Right now, though, higher yields are hammering stock valuations since investors can pocket more money by sticking it in safe assets. Tech stocks Tesla promise fast growth in years to come, but those lofty goals are harder to reach when the money needed to fund that growth comes with increasingly high price tags and investors get a higher return by simply parking their money in safe bonds.

“The tech stock sector is the most vulnerable from rising bond yields and will face the brunt of the decline,” said James McDonald, chief investment officer of Los Angeles-based Hercules Investments.

“Un other stock sectors cyclicals, stocks in the tech sector are valued on longer-term earnings. If bond yields and borrowing costs are rising, a company’s longer-term earnings may be negatively affected.

Inflation Concerns

Despite his best efforts, Powell can’t quite get investors not to worry so much about inflation. It’s a strange situation, especially when you realize that inflation hasn’t been a thing to worry about in a while.

The Fed’s stated goal is to keep prices rising by around 2% a year, as measured by the Core Personal Consumption Expenditures Price Index. Commonly known as Core PCE, this is the inflation measure the Fed uses when it makes projections.

The core in Core PCE refers to stripping away volatile food and energy prices, which tend to swing around widely month to month, season to season.

And you can see below that Core PCE inflation has spent most of the past decade or more below the Fed’s 2% target.

To address this long-term trend, Powell laid out a new policy last August in which the Fed would let inflation rise moderately above 2% for a spell without raising interest rates. In his recent talk with the WSJ, Powell said he wouldn’t raise rates even if the unemployment rate dropped to pre-Covid recession lows.

Basically, the Fed wants to see inflation rise quite a bit, and for a sustained period, before it even thinks about doing anything with interest rates.

This is making some investors very antsy, and they worry the Fed might end up in a position where it’s unable to stop a runaway train. Should prices pop later in the spring, after the economy begins to recover and more relief payments go out to individuals, these Chicken Littles may feel vindicated.

The conventional wisdom, though, is that any inflation pick-up would be short lived.

“We believe inflation will be more of a concern to markets in the near-term but not as much over the long-term,” said Rod von Lipsey, managing director of UBS Private Wealth Management.

“Year-over-year comparisons in headline inflation data will show a sharp increase over the coming months, which may spook markets, but we expect those elevated numbers to be short-lived and decline back near the Fed’s expectations of inflation by the end of the year.”

That’s Powell’s plan, anyway.

The Federal Reserve is in charge of monetary policy for the U.S., and the Federal Open Markets Committee (FOMC) is the committee that decides how to manage monetary policy. The FOMC meets eight times a year to debate interest rates, and vote on policies.

There are 12 members of the FOMC:

  • The seven members of the Fed Board of Governors, which is lead by Fed Chair Jerome Powell
  • Five of the 12 Federal Reserve Bank presidents, although the head of the Federal Reserve Bank of New York is a permanent member of the FOMC. The other four voting positions are filled on a rotating basis by the presidents of the other Federal Reserve Banks across the country. Even though most presidents don’t vote, they can all attend the meetings and debate policy.

The FOMC usually meets eight times a year, which translates to about once every six weeks. But the monetary governing body can meet more often if world events get crazy and the Fed believes it needs to act, such as during the outset of the pandemic.

The Fed had multiple unscheduled meetings in March when it decided to cut interest rates to near zero, and buy trillions of dollars of bonds to prop up the economy.

After this meeting, the FOMC meets on November 4th and 5th and then again on December 15th and 16th, the last meeting of the year. In that get-together, the FOMC will release a summary of economic projections, which lets the public know where it sees economic growth and inflation going in the near future.

The FOMC releases minutes of its meetings three weeks after the committee gathers. A full transcript isn’t available for a full five years after a meeting.

The Fed is unly to raise rates this year as the U.S. economy continues to recover from Covid-19. In fact, the Fed could wait until 2022 to increase borrowing costs following its announcement to let inflation run a bit higher than its 2% target.


New Fed policy could mean years of low mortgage rates | Mortgage Rates, Mortgage News and Strategy

Is a Fed rate cut all but guaranteed this year, thanks to low inflation?

Editor’s note: This article was originally published on September 1, 2020, and updated on September 15

Fed policy to help keep mortgage rates low

On August 25, Federal Reserve Chair Jerome H. Powell made an important speech that should be good news for borrowers and mortgage rates.

The FOMC meeting on September 15-16 should help clarify how the Fed’s new vision will play out.

Below, we’ll explain what it ly means for mortgage borrowers: continued low interest rates for years to come.

Get today's rates. Start here (Mar 26th, 2021)

Will the Federal Reserve lower rates again?

The fed funds rate is already sitting near zero (technically, it’s at 0-0.25%). That’s about as low as the Fed can drop it without diving into negative interest rate territory.

In past statements, Fed chair Jerome Powell has made it clear the Fed doesn’t plan to broach negative rates in the foreseeable future.

So borrowers shouldn’t expect a drop in the fed funds rate — or rates directly tied to it, credit cards, auto loans, and HELOCs.

But the good news is, we can ly expect rates to stay at their current low levels for quite a while. Here’s why.

New Fed policies mean continued low interest rates

In effect, the Fed has signaled that it won’t be tightening monetary policy for a long time, because economic recovery will be so uncertain post-COVID.

So interest rates are ly to stay low, probably for years.

And that should apply to mortgage rates, too.

As The New York Times put it in a recent article: “That could translate into long periods of cheap mortgages and business loans that foster strong demand and a solid job market.”

This does not mean rates are going to plummet; current home buyers and refinancers shouldn’t be affected too much.

But those looking to buy a house or refinance in the coming months and years should have low rates to look forward to.

Find and lock a low rate (Mar 26th, 2021)

What the Federal Reserve (normally) does

For a very long time, the Fed has had two main policy goals:

  1. To keep the inflation rate at an average of 2% per year
  2. To keep employment high and unemployment low

And you can see it’s generally done a pretty good job. The following graphs for the 21st century were retrieved from FRED, the Federal Reserve Bank of St. Louis:

U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis World Bank, Inflation, consumer prices for the United States, retrieved from FRED, Federal Reserve Bank of St. Louis

Yes, there were a few spikes and troughs, most notably in response to recessions (the periods shaded in gray). But there’s been nothing control. Until 2020.

Now, look at the unprecedented spike in unemployment at the far right of the top graph. It shot up to 14.7% earlier this year.

Yes, unemployment is coming down. But the unemployment rate in July 2020 was still 10.2%, which translates into more than 16 million people without jobs.

And we’re far from a guaranteed recovery after COVID — or even a guarantee that the pandemic could be close to its end.

With such a sharp change in the economy, and so much uncertainty about how long it will continue, the Federal Reserve has had to tweak its policies in order to meet those pillars of 2% inflation and high employment.

How Federal Reserve policy changed in response to COVID

Clearly, some special action was needed to address unemployment.

So Powell and his colleagues on the Fed’s top policy committee (the Federal Open Market Committee or FOMC) came up with a fresh approach outlined in their new “Statement on Longer-Run Goals and Monetary Policy Strategy“.

Essentially, that involved rebalancing the Fed’s priorities.

Inflation policy

Instead of regarding employment and inflation as equally important, it would for now work to stimulate job creation even if that meant giving inflation a slightly freer rein.

In his speech, Powell said:

“In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.”

Employment policy

And the Fed made a second change. Powell went on to say “the Committee did not set a numerical objective for maximum employment.”

So the Federal Reserve can continue to support employment growth, even when employment levels are high (and conversely, unemployment levels low).

In other words, it expects to be implementing economic stimulus policies for a long time to come.

Powell put it thus: “employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation.”

Impact on interest rates

To the average ear, the Fed’s new policies might sound too nuanced to have much of an effect.

As former Federal Reserve chair Janet Yellen said on Aug. 27:

“It seems a pretty subtle shift to most normal human beings. But most of the Fed’s history has revolved around keeping inflation under control.”

New policies mean the Federal Reserve’s target interest rate could stay the same or move lower even as the economy begins to improve.

“This really does reflect a decisive recognition that we’re in a very different environment,” Yellen says.

Markets and investors were quick to pick up on the meaning behind Powell’s statement. They recognized it as a very significant change.

That’s because it means the fed funds rate (the target interest rate) will ly stay the same (near zero) even if inflation rises over the 2% mark or the employment market runs hot.

But the Fed doesn’t set mortgage rates, right?

Every time the Federal Reserve announces a change in its interest rates, loan officers and mortgage brokers are bombarded with calls from borrowers asking what that means for their mortgage rates.

The standard reply is, “Nothing. The Fed doesn’t determine mortgage rates.”

And they’re quite right. Changes to the Fed Funds rate directly affect a whole lot of loan products, but not mortgages (except for existing adjustable-rate mortgages (ARMs)).

How mortgage rates are determined

Mortgage rates are determined by supply and demand in a ‘secondary market,’ where mortgage-backed securities (bundles of mortgage interest) are traded. And, normally, the Fed gets no say in that market.

The Fed has had a bigger impact on mortgage rates recently, because it’s been buying mortgage-backed securities itself. But that’s a temporary intervention and a distraction from normal principles.

However, Federal Reserve policy changes do affect the overall mood of the market. And that can have an indirect effect on mortgage rates.

What the Fed’s change means for mortgage rates

Within a couple of days of Powell’s speech, at least one lender was advertising, “Fed stimulus cuts mortgage rates — Fed stimulus pushes mortgage rates to insane lows.”

It’s not clear whether that referred directly to the latest announcement, or to the organization’s earlier actions.

But it reflects a general feeling that the latest news the Fed is good for mortgage and refinance rates.

Those in the process of buying or refinancing should not wait to lock a rate. Mortgage rates are already near record lows and not expected to drop much further.

However, it does not mean that those who are in the process of buying or refinancing should wait for rates to fall before they lock.

Average mortgage rates have only inched down since Powell’s speech. And they’re already near record lows — so borrowers shouldn’t expect drastically lower rates thanks to the Fed’s action.

Rather, Powell’s announcement should be seen as good news for those who want to buy or refinance in the future, because rates are ly to stay at or near their current levels for quite some time.

Long-term dangers

And there are those who fear the long-term consequences for mortgage rates.

Writing for Mortgage News Daily, industry guru Matthew Graham warns of the dangers of the Fed taking its eye off the inflation ball: “High inflation is bad for low rates. It also connotes a higher comparative level of economic activity and employment. Those things are also not good for rates.”

And he’s right. The last thing investors want is to be stuck with a load of fixed-rate, low-yield, mortgage-backed securities during a time of high inflation. They inevitably lose money.

Lower mortgage rates still the ly outcome

But, for now, those investors have a lot more to be worried about than possible future inflation. And few expect either inflation or employment to reach worrying levels for years.

So it looks ly that the consensus view that Powell’s speech will be good for mortgage rates will hold true for the time being. Let’s hope that time ends up being several years.

Your next steps

If you’re already in the process of buying or refinancing, the Fed’s recent announcement shouldn’t affect you too much.

Rates are already ultra-low and not ly to plummet Powell’s statement. So there’s no real reason to wait on locking.

But if you’re planning to buy a home or refinance somewhere down the line, take heart. It seems newsworthy rates aren’t going away any time soon.

Verify your new rate (Mar 26th, 2021)


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