Earth to Federal Reserve: What are you waiting for?

This is the same headline I used in February 2022 in this article, when the Federal Reserve (Fed) was dithering about raising rates. It is just as applicable today as they dither about cutting rates.
Indeed, sometimes I wonder if the Fed is more concerned about coming up with catchy phrases: “transient inflation; “data dependent”; “higher for longer”; and now “data-dependent, not data point dependent” – than actually taking decisions.

“Date-dependent mean the Fed doesn’t have a clue”
This was a heading in an earlier Bloomberg article, which continued: But perhaps the bigger takeaway is that Chair Jerome Powell and his fellow policymakers really don’t have a clue what’s going to happen in the economy. They’re shooting in the dark. “They’re making it up as they go along.”

These comments may seem harsh but it expresses the frustration many feel about what I described in this recent article: The Federal Reserve’s Analysis Paralysis

The data is unreliable and subject to change
Mohamed El-Erian, whom I often quote, captured the current state of affairs when he observed: “I think the major issue is that the market has become overly data-dependent, just like our central banks have become overly data-dependent. So, we’re not looking beyond the next data release because we’re worried about what will the Fed do in September, what will the ECB (European) Central) Bank) do in September.”

Central bankers and markets should be aware of the risks associated with an overly data-dependent approach to monetary policymaking. In 2019, Powell himself highlighted the basic challenge: “We must sort out in real time, as best we can, what the profound changes underway in the economy mean for issues such as the functioning of labor markets, the pace of productivity growth, and the forces driving inflation.”
Yet economic data are often unreliable. Official statistics undergo multiple and often substantial revisions. For instance, the payroll numbers undergo subsequent revisions —sometimes large ones that give the lie to the initial perceptions.
Richard Fisher, a former Dallas Fed president, once offered an example of the dangers involved. Data pointing to excessively low levels of inflation had prompted the Fed to keep rates low in 2002 and 2003. Subsequent revisions, he acknowledged, showed that “inflation had actually been a half point higher than first thought. In retrospect, the real fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been.”

In a recent Financial Times article, Mohammed-El Erian asked a number of questions, amongst them:
Why did Fed forecasts get it so wrong, be it on inflation or unemployment — the so-called dual mandate — in recent years? And to what extent has this resulted in a longer-term shift to excessive data dependency in the formulation of the central bank’s policy?

Ongoing structural and secular changes in how the US and global economies function are more consequential for policy design than “noisy” short-term data. So, is it not now time to combine data dependency with a much greater injection of forward-looking strategic thinking? (more…)

Why Mortgage Rates will fall in 2024

This article addresses two things: what drives mortgage rates, and why they will fall in 2024.

What drives mortgage rates?
The Federal Reserve (Fed) meets regularly and announces, with great fanfare, its “Federal Funds Rate(FFR).” But what is this interest rate and what does it influence?

The FFR is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. It is this rate which impacts the interest rate on many consumer loans, such as credit cards and automobile loans, but NOT 30-year Fixed-Rate Mortgages (FRM).

In general, FRM are sold to Fannie Mae and Freddie Mac and are bundled into portfolios which are sold to investors as Mortgage-Backed Securities (MBS). The yield investors demand for MBS is based upon the yield on the US Treasury 10-year (10T) yield, and the extra yield investors want to buy MBS rather than just risk-free Treasuries.

Look at this chart showing the three rates (FRM, FFR and 10T) over the last year. Note that the Green (FRM) and Red (10T) lines move in tandem, while the blue line (FFR) does not move with either of the other two. Thus, the FRM is determined by the yield on 10T, which is set by the market, and not by the Federal Reserve.

The Spread
The spread – reflecting the extra yield investors want to buy MBS –  between FRM and 10T this year has between 2.5% and 3.2%. That is unusually high, as we shall see.

Why Mortgage rates will Fall
And now to the forecast. The spread between FRM and 10T is much higher than it is in “normal” times. Look at this chart going back to 2005:

For most of the last 18 years the spread has been in the 1.6 – 1.8% range and has averaged around 1.75%. The exceptions have been:
2008 – the Great Recession and the height of the foreclosure crisis making mortgages unattractive to investors, who demanded higher yields
2020 – at the outset of the pandemic, amidst widespread uncertainty, spreads widened before the Fed started its huge program of pouring money into the economy, buying both Treasuries and MBS and igniting an asset boom
2022-23 – when the Fed finally, belatedly, stopped injecting liquidity into the system, the market reacted to two main factors: the Treasury would need to sell a lot more Securities to fund the spending, and the growing Budget deficit; and the fact that the biggest buyer of Treasuries – the Fed itself –  was switching from being a buyer to a seller.
This resulted in the most basic economic equation – more sellers than buyers, so the price of Treasuries went down and the yield (which moves inversely to the price) went up.

How far will mortgage rates fall?
Few if any forecasts have been accurate over the last few years, so it would be foolish for me to suggest a timeframe.
What is less foolish is to suggest that the era of cheap money over the last 15 years has ended. It is only in that period that the yield on 10T has been below 4%, and a sustained return to a 4% yield on 10T is likely.

That in turn would suggest a sub 6% FRM.
Not 3%, but better than 7.7%.

And these recent articles:
Most Sales Still Over List Price
Core Inflation Prices Barely Budged in August
MARBLEHEAD Q3 MARKET REPORT 2019-2023
SWAMPSCOTT Q3 MARKET REPORT 2019-2023
SALEM Q3 MARKET REPORT 2019-2023 (more…)

Two More Ways the Mortgage Market differs from 2007/2008

The chart below shows how loans with a credit score under 660 – the bottom colours of yellow and dark blue – which were about 20% of the total in the 2004-2007 period, have virtually ceased, with loans over 720 now making up the vast majority of new mortgages.

Two other changes:
Adjustable-rate mortgages can lead to higher default rates when interest rates rise, but they now represent less than 5% of total purchase and refinance loans, compared with over 35% at the peak of the pre-GFC (Global Financial Crisis) housing cycle. (FORTUNE)

The ratio of Americans’ mortgage debt to their real estate assets—also called loan-to-value—was just 27% in the second quarter, compared to over 40% in 2008 and roughly 50% in 2010. (Bank of America)

And these recent articles:
Core Inflation Prices Barely Budged in August
Two More Ways the Mortgage Market differs from 2007/2008
October Inventory shows Sharp Jump from September
Credit Score Change Could Help Millions of Buyers (more…)