You might think the big economic news this week was the .25% increase in the Federal Funds Rate to a range of 1% to 1.25%, but the real news is that the Federal Reserve raised short-term rates even though there are signs that inflation is cooling. With unemployment at 4.3%, economists have been confounded as to why wage inflation has not appeared. The Fed explained their rationale for raising rates on the basis that price inflation and wage inflation will eventually make its way into the economy and that low inflation is probably temporary. Overall, inflation remains below the 2% target rate. The jury is still out whether or not the Fed’s thesis will hold true.
Psychologically, the Fed’s rate increase telegraphs its confidence an overall improvement in the US economic picture. Surprisingly, bonds rallied lower Wednesday in anticipation of this announcement with the 10-year U.S. Treasury touching its lowest level this year. Equities also traded well. Bond traders are closely watching the 2-year-to-10-year Treasury spread which continues to flatten and may be signaling a slowdown in the economy. A flattening yield curve is never a good sign, but so far the markets have not been deterred by this pattern.
In other news, May housing starts fell 5.5% from April to an annual rate of 1.092 million units, well below the 1.227 million expected. It was the lowest rate since September 2016 and the third straight month of declines. Starts are down 2.4% from May 2016. A larger drop was seen in the multi-family home sector. A slowdown in housing starts is likely to weigh on economic growth, which is good news for bonds and the continued trend of low interest rates.
We continue to watch rates and rate spreads as we advise clients on mortgage rates and remain cautiously biased toward floating interest rates given that bond yields responded well to the Federal Reserve’s decision to raise short term rates.