Bonds Rally As Recession Worries Intensify
The U.S. equity markets proved resilient taking on both a .75 bp Fed rate hike and a GDP print confirming that the economy is technically in a recession. Two negative quarters of real GDP growth support this status. Inflation continues to be a problem but has likely peaked with the Personal Consumption Expenditure (PCE) coming in at a multi-decade high, but flattening out on month-over-month readings. Now, the great unknown is the pace at which inflation moves off its highs. The Fed’s goal of 2% inflation seems almost fanciful near term. The truth is inflation will be with us for quite some time.
For Better Or For Worse?
Parts of the yield curve have been inverted. An inverted yield curve remains one of the best indications that the economy is in poor shape and financial conditions have perhaps tightened too much. One must not discount the threat of stagflation, should inflation become embedded in the prices of goods and services even as the economy slows. The equity market is forward-thinking, so even with sagging consumer and business confidence amidst a host of other negatives, the market found a way to rally. Perhaps the worst is behind the markets. Or perhaps, it is a bear market rally. Only time will tell. It is important to remember Fed rate hikes need some time to work through the system. Also, come September, the Fed will be selling close to 95 billion in bonds as part of its QT plan. It will be an interesting third and fourth quarter.
Troubles abroad cannot be dismissed either. Whether it’s the Russia-Ukraine War, European or Chinese economic slowdown (worse than what the U.S. is currently experiencing at the moment), geo-political tension, or global run-away inflation, the world continues to experience great economic stress kickstarted by the pandemic. Joblessness on a global scale will likely increase as many large businesses are cutting back on hiring. If the goal of the Fed is to break inflation, one unfortunate truth is that job casualties will be unavoidable.
As expected, home prices are starting to fall in response to higher interest rates and stricter bank underwriting. To their benefit, buyers have found themselves more optionality and a selling environment where they have a seat at the negotiating table. Mortgage rates have come down lightly as 30-year fixed rate money note rates can be found at 4.75% or below. No doubt a big move from the sub 3% range, this same product was being offered at a short while ago but removed enough from the high of 6% plus not too long ago. The move lower in mortgage rates should help some buyers make offers on homes. Adjustable rate mortgages follow the 10-year U.S. Treasury. As the 10-year Treasury moves lower so do ARM rates. This may take some time as lenders are being cautious given the current headwinds. This should be a boon for the high-end market, especially if sub 4% interest-only mortgages are offered again.