U.S. Posts Strong Economic Data As Rates Remain Low

The pace of economic growth in the first quarter of 2021 clocked in at a 6.40% annual rate which was a huge pick up after Covid-19 essentially shut down the global economy this time last year. Consumer spending led the charge as stimulus checks encouraged spending. Business spending remains robust as does durable goods spending. Spending would have been even better were it not for the constraints that a shortage of semi-conductor chips critical to many fundamental products and industries, such as computers and cars. Ford recently stated that the chip shortage has been disruptive to their ability to managing their inventory and deliver new products to the marketplace.  

Big corporate earnings are shaping up to be excellent overall. With the U.S equity market trading at all-time highs, the response to fabulous earnings was muted. Inflation concerns continue to circulate, but for the moment, bond traders are in sync with the Fed and the Fed’s belief that inflation is transitory and will settle down. However, there is some concern that the Fed’s measures on inflation are not taking into account how expensive it is for everyday Americans to buy goods and services. Lumber, copper, gas, and food prices have all surged, as have home prices and equity prices. Wage inflation is also rising as many companies cannot find workers willing to work unless they are paid higher wages. Should the bond market get spooked by the threat of inflation running hotter than expected or not being transitory, higher interest rates could hurt both equity and housing markets as prices are already very high and could pull back with higher financing costs. 

The Biden tax proposal is ambitious. How it affects investment is an open question, but if the tax proposal removes 1031 exchanges, this change will put real pressure on expensive real estate markets such as California and New York. I often think about what could disrupt our local market and I think the removal of this tax break along with higher taxes on the wealthy will hurt California real estate overall as higher taxes will discourage risk-taking. However, for now, rates remain low and banks are eager to lend as we encourage all of our borrowers past and present to take advantage of extremely accommodative lending conditions.   

Mortgage Rates Lower Even With Talks Of Higher Taxes & Growing Fears Of Inflation

The U.S. economy appears to be on good footing. Corporate earnings are easily beating expectations. For the moment the bond market is calm even as many companies state their intentions of raising prices due to rising input costs. Bond yields have fallen back down to the 1.50% range which was helping high beta growth stocks rise. The one big spook to the market this week came by way of a Bloomberg report announcing major tax hikes on capital gains for the highest-earning Americans. While that caused a sharp sell-off Thursday, equity markets bounced back Friday. It is too soon to really know how this tax increase will play out, but should it pass the Senate, it seems reasonable that it will be a negative for risk-taking which includes buying stocks and more speculative investments.  

With so much liquidity sloshing around and so little yield, money is flowing into equities, crypto, and real estate. Bitcoin fell hard this week which speaks to this new digital money’s volatility and why it is still hard to understand how one can transact with a currency that moves around so much day today. Should Bitcoin go down dramatically, I imagine it will hurt other parts of the investment market given the bullish nature of so many on this investment.  

Regarding real estate, housing remains on a tear although rising prices and lack of supply are of concern. Banks continue to compete with each other, especially for wealthier clients and with the return of many products in the non-QM space, most borrowers are being approved for home loans, even those borrowers with trickier income or lower credit scores. However, lenders are requiring skin in the game (anywhere from 10% to 20% on jumbo loans, and at least 10% for better-priced government loans), which is keeping borrowers honest and prices from soaring higher. 

Rates Move Lower Surprisingly As Inflation Data Picks Up

Treasury and mortgage bond yields dropped despite better than expected inflation data. This came as a surprise to some as the Fed and Treasury are doing all they can to spur inflation. They have indicated that their belief is that any inflation created by massive government spending can be controlled. While only time will tell, for the moment bond traders are believing what the Fed is saying, and that is why rates did not run away based on the hotter than then expected CPI data. 

Equity markets and alternative asset classes love low rates. Stocks had a good week. Positive economic and earning data from banks continue to support the improving economy. Housing remains on fire and in fact, there is still a major housing supply shortage which should serve as a floor to housing prices drifting lower even if rates increase over time. 

Inflating people’s savings through their investments in various retirement accounts is good for consumer psychology. We tend to spend more when we feel wealthier. During the pandemic, a lot of that spending has gone into home purchases and home improvement. Low interest rates also have put more dollars in people’s pockets which then gets spent on other activities.  

Unemployment gains were down this week. While there remain concerns about Covid-19 abroad, ongoing vaccinations in the U.S. combined with the entire population getting closer to herd immunity are unleashing animal spirits. Restaurants are bustling, people are out and about, and the airlines are reporting more booked seats on flights. The economy will boom this year as long as the virus outbreaks remain contained as people learn to enjoy life while taking precautions. As the summer approaches, unemployment should continue to fall and the economy should recover to 2019 levels toward the end of the year. 

March Jobs Report Supports Improving Economy. Bond Yields Tick Higher But Are Still Attractive.

The March 2021 jobs report was massive with 916,000 new jobs created last month. Unemployment fell to 6%. Challenges remain as long-term unemployment remains elevated and is a top concern of Fed policymakers. 

Bonds edged higher in light trading as the stock market was closed in observation of Good Friday. Bonds were also pressured this week by the announcement of a major infrastructure spending package. The plan has both pros and cons, and to date, both the bond and equity markets have responded well to the new plans to upgrade the United States which also includes corporate tax increases. As this plan makes its way through Congress, we do expect to see more volatility in the public markets expressing bond traders’ concerns about the size of the government’s balance sheet. Equity markets don’t like tax increases on corporate earnings nor the potential for higher interest rates. 

The S&P 500 surpassed the 4,000 milestone and economic activity continues to improve as vaccinations take hold and life starts to return to normal. Air travel and hotel bookings are an upswing. Consumer confidence and business confidence also are improving. 

Home sales remain strong but the overall housing market is under some pressure. Supply has been limited, and tat has driven up prices. Large traditional lenders remain very rigid in underwriting, but we’ve also seen the return of alternative loan programs including one-year tax return loans, W-2 only, and bank statement loans. Also in the mix now, CFDI programs are helping borrowers purchase or refinance debt. Rates remain attractive, fueling much activity. To help cool off speculation, Fannie Mae and Freddie Mac have added additional hits to disincentivize second home and investment home transactions to reinforce their focus on primary homeownership. The fallout of that benefits independent brokers like Insignia and our clients because we have access to lenders who are eager to lend to good borrowers at attractive rates who want to buy second homes and investment properties.

Rate Volatility Persists As Economy Gains Momentum

Bond yields moved marginally higher in the back half of the week as Wall Street worked through how to balance a strengthening economy against massive fiscal and monetary spending some experts believe will create an inflationary period last seen in the 1970s. The bond market is not totally buying the Fed’s assertion that inflation can run hot and then be tamed. Stimulus and transfer payments are in the trillions of dollars and we’re seeing tweaks to long-held mandates. This is an experiment in financial engineering the likes we have never seen domestically, nor globally. Who knows how far the Fed can push its powers to control inflation, keep rates low, while also helping the economy to create jobs. As the $3 billion infrastructure bill being passed along with potentially higher taxes, the back half of 2021 is shaping up to be very interesting.  

The worries over inflation for the everyday person are most felt through the impacts of increased costs of lumber, oil, and food prices. These costs filter up to the costs of buying a home, driving and purchasing cars, and feeding our families. CPI data continues to support the notion of minimal inflation, which may be confounding for the average American. The relatively low levels of money velocity, many millions of still unemployed or underemployed, and the near-certainty of a tax hike, are all deflationary. These are part of the reason that the Fed is not worried about inflation (yet!), and why inflation readings remain low. For now, inflation is under control and that should cap how high bond yields rise.  

All the stimulus put forth by the Fed and Congress have benefitted housing and housing-related activities. While there is much media chatter about higher interest rates, bear in mind that rates are still very low historically (remember the 1980s?) and banks remain eager to lend to qualified borrowers. There will not be a linear rise in rates, but we continue to keep an eye on Treasury yields with the 10-year trading well above 1.600%.

Rates Jump On Dovish Commentary From Fed

The bond market did not respond well to Fed Chairman Powell’s recent comments, especially when it came to letting inflation run hot. For those of us who follow the gyrations of the bond market daily, inflation has historically been the arch-enemy of bonds as higher inflation reduces the real return on bond investments. The idea of encouraging inflation to run hot and above the traditional 2% threshold is novel. Bond traders remain skeptical as the 10-year Treasury reaches levels last seen pre-pandemic. Bonds are also under pressure by the Fed’s announcement that the temporary change to the supplementary leverage ratio will run off at the end of March and also that banks will be required to lift reserve requirements. This news has added additional pressure on bond yields as banks are large holders of these instruments and now must sell them to raise capital. 

Further muddying the waters is the threat of new lockdowns in Europe and India (which creates some uncertainty on the future path of the virus and could create havoc for all investable markets)  as the virus surges in those areas and vaccinations have not been delivered in nearly the same capacity as in the U.S. Also, let’s not forget the increase in oil prices, lumber, oil, and commodities, all of which support the inflations argument, while the U.S. economy is improving. The Philly Fed Manufacturing Index also soared, which is yet another positive indicator that the economy is on the mend. 

As we have written about previously, long-duration growth/tech equities are most at risk in a rising rate environment as are speculative investments, which are priced much higher based on a very low discount rate.

We are watching how equities and bond yields react as the pandemic becomes less of a problem. An unexpected housing boom was a welcome surprise during the pandemic year and was spurred on by a rise in equities paired with low-interest rates.

However, as rates move higher, monthly mortgage payments will increase, potentially cooling both purchases and refinances. Keep in mind that the 10-year Treasury is still well below 2% and that while we are off the bottoms, interest rates are still very low historically.

Massive Stimulus Package Pushes Bond Yields Up

Interest rates are rising. This should not come as a surprise given the combination of new factors. Increased vaccinations are lighting a fire of greater economic activity and lowering unemployment. There’s the new massive $1.9 trillion stimulus package. Prices are on the rise for basic goods such as food, lumber, gasoline, and more. Assets such as equities, real estate, and Bitcoin have been soaring to record highs. But that is the type of inflation everyone loves. Consumer inflation, the everyday rise of the price of goods and services, is the greater concern. Personally, I was astonished the other day when I went to the market. Prices have certainly risen to the point where I took notice.

It is hard to square the massive government spending against extraordinary low interest rates, especially as the world recovers from Covid-19. Something will have to give and it is probable that investors will demand higher yields for buying our debt. Should rates grind higher, expect a cooling of long-duration growth stocks. It may also affect high-priced real estate, and speculative plays on crypto-currency. Perhaps many homeowners are also thinking the same thing as purchases, rates, and term refinances roar on. Especially interesting is the rise in cash-out refinances. Cashing out of your home with an interest rate below inflation is a wonderful thing as you ensure paying off debt with inflating dollars. There is a point not too far from where we are trading where higher interest rates will cool off the mortgage market, as well as, limit how high home prices can go. For the moment, with the 10-year Treasury trading at 1.61%, interest rates are still highly accommodative.   

Be prepared for a quick move to 2.000% on the 10-year Treasury if rates steady above 1.600%. We are actively watching the bond market; we do our very best to navigate borrowers during this very volatile time. The bond market sure appears to want to test Fed policy and challenge some of the exuberance in the equity market. With rates in a rising channel, for those actively looking to buy or considering refinancing, there is no time like the present.