Market Commentary 9/15/2023

Additional Fed Hike by Year End Suggested by High CPI Readings  

Bonds continue their upward trajectory in response to the latest CPI and PPI inflation readings. As we’ve often pointed out, the path from 3% to 2% inflation presents many challenges. Both the Federal Reserve and the average American consumer face escalating home prices, rising food costs, and surging energy expenses. 

While financial experts may attempt to interpret inflation reports in various ways, we believe it’s crucial to focus on food and energy costs. These commodities, although volatile, are indispensable elements of our modern world. Therefore, the persistent high costs of food and energy, coupled with ongoing wage inflation, are likely to keep the Federal Reserve from implementing any interest rate hikes in the upcoming week. Our expectation is that they will project an additional rate hike in November. Furthermore, it’s prudent not to anticipate any rate cuts from the Fed until at least the end of next year. 

In the broader real estate market, office spaces continue to face problems. Nevertheless, there is a growing trend of companies reintroducing return-to-office requirements for employees. This shift could establish a floor for declining office values. In certain cities, office property values have plummeted by over 50%. What was once deemed a prime asset class is undergoing a transformation. Newer, amenity-rich office spaces may thrive, while older, cash-cow office buildings owned by generational landlords might ultimately be more valuable as land than as operational structures. However, there is emerging concern about the multifamily real estate sector, as a substantial amount of multifamily CMBS debt is set to mature in 2024 and 2025. In contrast, the single-family homes market remains largely unaffected by rising interest rates. This is primarily because many potential sellers are holding onto mortgages with rates below 5%. Such favorable rates are discouraging homeowners from listing their properties for sale.  

Our attention is now focused on the 10-year Treasury yield, which recently closed just below 4.35%. Should it breach this level, yields will likely surge past 4.5%. There is currently little evidence to suggest that interest rates will move lower. It’s worth noting that interest rate cycles tend to be lengthy, a point emphasized by the renowned bond investor Bill Gross, often referred to as the “Bond King.” Gross once underscored the significance of the 30-year bull market in bonds, where declining rates are considered bullish in bond markets, as one of the defining features of his career. 

Market Commentary 7/14/2023

Mortgage Rates Rally On Cooling Inflation Readings

The latest CPI data indicates that inflation appears to be moving in a favorable direction. The Producer Price Index (PPI) also experienced a decline, which was well received by both the bond and equity markets (PPI measures production costs). Although another 25 basis point rate hike in July is widely anticipated, further increases in the near term seem unlikely. Nonetheless, given the persistent nature of current inflationary pressures, there is concern that a thriving equity market could spur increased spending… Which would potentially lead to a resurgence in inflation. It is worth noting that speculative areas of the equity market, such as Crypto and AI, have performed exceptionally well. Such positive performance suggests the Fed may believe more action is necessary to curb inflation. While higher rates may not be imminent, it is our belief that the Fed will maintain higher interest rates for an extended period, considering that equities have nearly recovered most of the losses incurred in 2022. Additionally, we expect the Fed to continue with quantitative tightening until a significant crisis emerges.

JP Morgan’s better-than-expected outlook for the second quarter has set the tone for earnings season. Wells Fargo, among other banks, also reported earnings and increased loan loss reserves for its commercial portfolio. In the coming weeks, we predict more write-downs of office loans from regional banks, given their significant exposure to commercial office loans. A 2008 redo appears unlikely even as some parts of the commercial real estate market experience growing stresses.

There is a noticeable uptick in purchase money loan activity, potentially driven by added inventory within certain areas. This observation is based on local market assessment, including discussions with realtors, monitoring real estate websites such as Zillow and the MLS, and the presence of more “for sale” signs in the neighborhood. Pre-approval activity is escalating, with a majority of pre-approvals falling within the $1 million to $3 million price range. In terms of refinances, we are seeing a growing number of requests. The majority of these refinance requests are coming from self-employed borrowers who aim to consolidate higher-interest business debt, credit card debt, or commercial debt through a home loan refinance.


Market Commentary 3/15/19

Easing global monetary policy continues to provide the tailwinds pushing mortgage rates lower and equity prices higher. Recent confirmation from the February PPI and CPI also confirmed that inflation remains in check. As stocks have gained back most of the losses from late last year, risk is back in vogue. 

Reduced mortgage rates have arrived just in time to boost what has been a slowing new market for the new and resale housing market. Recent stories on the glut of high-end homes (those over $10 million) have brought back the conversation as to whether and when housing will reset much lower. Our view is that a glut is unlikely given the strict underwriting guidelines that banks continue to follow. If anything, the return of low-interest rates may ignite a better than expected spring buying season in housing.

However, fears remain in the highly leveraged first world economies, especially in the corporate and government debt markets.  As previously mentioned, QE has created absurdly low rates around the world and true price discovery is difficult to attain.  Geopolitical events such as China trade talks, Brexit, and Italian debt levels are also worrisome, as well as the slowing of the global economy.  Low rates work as a tonic in addressing these issues and central banks realize that.

With the 10-year Treasury dipping below 2.600%, locking is not a bad idea.  However, given where European and Japanese bonds are trading, rates in the U.S. may go lower.  Be careful what your wish for, as lower rates may mean trouble ahead.  For now, all looks to be OK and borrower appear to be taking advantage of renewed low rates for both purchases and refinance. We continue to be cautious and are biased on locking-in interest rates at these levels.