Optimism Improves, Rates To Firm Anew

October 11, 2019 -- Interest rates have been on mostly unsteady ground over the past few weeks, with increases nearly as likely as declines. That's to be expected at a time when central bank policy is changing, the domestic economy cooling somewhat and the global economy less than sanguine and full of various headwinds. At times, investors with a sunnier outlook hold sway, and rates firm up, only to be followed in short order by those who hold a dimmer view, and rates head back down again.

Influencing these dispositions are of course the fractious political climate -- not only here in the U.S., where an impeachment inquiry continues apace, but also overseas, as warring factions try to hammer out a Brexit everyone can live with, military considerations in the middle east, the election cycle coming into sharper focus and plenty of other things.

In this mess, central banks around the globe are trying to provide offsets for the damage occurring from trade wars and tariff impositions and the far-ranging economic effects these abrupt changes are having on individual and global economic activity. At the same time, the U.S. continues to release record amounts of new debt, and the ebb and flow of markets has seemed a little stronger since the relatively quiet days of summer passed.

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We know from the statement at the end of the last Federal Reserve meeting that not all participants agreed that rates should be cut, or even how much they should be cut. This week, we learned from the minutes of the last meeting of the European Central Bank that there wasn't exactly total agreement with Chairman Draghi's push to not only lower rates further but also to re-start a QE-style bond-buying program. The central bank heads of France and Germany, two of the biggest countries in the Euro bloc, oppose the new program and others have expressed concern that trying them into the open-ended program could tie the ECB's hands, overstep previously agreed-upon program limits and more. As well, the ECB will be transitioning to a new Chair shortly, as Christine Lagarde takes the helm.

News of the division among the ECB's members spooked bond markets overseas, and so a bit of a selloff took place, which in turn lifted yields here in the U.S. a bit late in the week. The lift in bond yields here was reinforced to a degree by the release of the minutes of the September Fed meeting. Although the Fed cut rates in mid-September and left the door open for additional cuts, there was some concern expressed that the financial markets are expecting far more accommodative policy from the Fed -- that is, a much deeper cuts in rates -- than the Fed itself thinks likely.

The minutes noted: "With regard to monetary policy beyond this meeting... financial markets were currently suggesting greater provision of accommodation at coming meetings than [the FOMC] saw as appropriate and that it might become necessary for the Committee to seek a better alignment of market expectations." As well, they also wondered about what to tell the markets "when the recalibration of the level of the policy rate in response to trade uncertainty would likely come to an end." In essence, that the Fed cut rates due to low inflation and the trade war, but that in their judgement there are limits to how many rate cuts that the current situation requires -- and we may soon be at those limits.

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It bears remembering that Fed Chair Jay Powell characterized the decision to cut rates as a "mid-cycle adjustment" in policy, a tacit admission that the last couple of rate hikes were a little premature and so some back-tracking is in order -- but all in the context of an upcycle that may resume at some point, even if it pauses for a while.

The the Fed might be done cutting rates before long saw some adjustments in investor stances and helped keep underlying yields firmer at the end of the week than where they began it. Then, on Friday, news that the U.S. and China may have reached a "substantial, phase-one" agreement to ease trade tensions that would see China promise to buy more U.S. agricultural products while the U.S. removes a planned increase in tariffs slated to kick in next week. If any progress is being made on trade, the prospects for somewhat more global growth are improved, and that would likely mean the Fed won't feel compelled to cut rates more or soon. The news of at least a truce in the trade way sent yields higher still as markets came to a close in Friday.

In a related-but-not-related action, the Fed has restarted a "not-QE" program of buying up Treasury Bills in order to maintain ample liquidity in the overnight lending, reserves and repo market to the tune of up to $60 billion per month through at least the second quarter of last year. A few weeks ago, overnight lending rates for reserves shot higher as end of quarter issues and tax payments made available funds scarce. The unwanted fluctuation of short-term rates above the Fed's desired range for the federal funds rate poses an unwanted challenge in implementing monetary policy and the availability fresh cash to buy bills as needed should help to ameliorate such episodes.

There doesn't seem to be much impediment to the Fed cutting rates again when it meets next in just a few weeks' time, if a consensus can be built. Certainly, economic growth is slow and slowing, reckoned at third-quarter run rate of just 1.7%. As well, inflation remains mild, as even if we see some signs that core inflation is pretty close to the Fed's desired level it's not at a level or trending quickly as to give them pause. In fact, the latest data on inflation as measured at Producer, Consumer and Import/Export locations in the economy were all pretty mild in the last month.

The Producer Price Index for September posted a 0.3% decline in September, dragged down by softer energy costs during the month, but even excluding food and energy costs left the so-called "core" PPI with a 0.1% decline for the period. Over the last year, prices measured upstream of the consumer are running at a meek 1.4% rate at the headline and just 0.9% at the core. Certainly, nothing to get excited about there.

Downstream of producers, the Consumer Price Index came in unchanged for September after rising by the barest amount possible in August. With the no-change status, headline CPI is rising at just a 1.7% clip over the last year, a mellow level at most. Digging deeper into the CPI report and eliminating volatile food and energy costs from the review showed that core CPI rose by all of 0.1% last month; however, where the top-line figure is in a flat-to-softer pattern, core CPI over the last year remained at a firm 2.4% for a second consecutive month, tying a level that was more than a year's high. Now, the Fed prefers to track inflation using a core measure of Personal Consumption Expenditures (PCE), which tends to run below core CPI but is influenced by many of the same factors, so prices measured their are likely to also be in a steady-to-firming pattern, too.

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Likely influencing costs at the producer rather than consumer levels, prices of imported goods coming into the U.S. rose by 0.2% last month, a bit warmer than expected, but no matter. On a year-over-year basis, costs of these goods have been declining for the last six months, and are currently 1.6% below year-ago levels. That's much the same story for goods headed away from the U.S., where September's 0.2% decline helped reinforce the declining pattern for the last six months, with prices of exports now also declining by 1.6% relative to the last year.

If the U.S. economy was faltering, we'd likely see that reflected in a souring labor market or a sustained drop-off in consumer borrowing and spending. So far, that's nowhere to be seen; the last hiring report was solid enough, weekly unemployment claims remain close to cyclical lows (just 210,000 new claims filed in the week ending October 5, for example) and retail sales have been pretty firm for months, at least through August. In August, consumers borrowed a fresh $17.9 billion on various forms of non-mortgage credit, a level good enough to be the second highest in 2019, if a bit of deceleration from a July borrowing binge. During the month, borrowing on credit cards went negative by $1.9 billion, indicating that folks paid down outstanding balances after running them up by $9.4 billion in July. The pattern here has been mostly back and forth for months, borrowing one month and repaying the next, so it would seem that folks are managing well of late. borrowing on installment credit, commonly used for cars and education, did expand sharply, with new balances on those loans rising $19.8 billion, the biggest one-month splurge since August 2016. Borrowing can be seen as an expression of confidence that tomorrow's income will be sufficient to cover today's purchases, and so if economic worries were increasing we'd likely see a lot less of it.

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Current Adjustable Rate Mortgage (ARM) Indexes

IndexFor The Week EndingYear Ago
Oct 04Sep 06Oct 05
6-Mo. TCM1.74%1.88%2.41%
1-Yr. TCM1.66%1.72%2.62%
3-Yr. TCM1.44%1.42%2.94%
5-Yr. TCM1.43%1.38%3.01%
10-Yr. TCM1.60%1.52%3.14%
Federal Cost of Funds2.200%2.260%0.947%
FHLB 11th District COF1.155%1.155%0.680%
Freddie Mac 30-yr FRM3.65%3.56%4.90%
Historical ARM Index Data

Consumer moods do remain fair and even improved a bit in early October. The preliminary reading of Consumer Sentiment by the University of Michigan saw its barometer rise by 2.8 points, moving back up to 96.0 and continuing a rebound from an August slump. Assessments of current conditions improved notably, rising 4.9 points to 113.4, it's highest level of 2019, while those for the future only edged higher, rising 1.4 points to hit 84.8 for the early-month reading. Moods are holding up well despite a strike by GM workers, the impeachment mess in Washington and a generally softer economic climate, so the odds still favor a consumer who is willing to borrow, spend and power the economy.

Inventories at the nation's wholesaling firms increased in August, expanding by 0.2%. That was a smaller buildup of goods than was expected but matched July's increase. Holdings of durable goods rose by 0.3%; non-durable goods by just 0.1%. Reflective of the more cautious business climate of late, sales were unchanged in August from July, so the ratio of goods on hand relative to sales remained at 1.36 months for a fourth consecutive month. While not excessively bloated, inventory levels are high enough as to not see much need for new orders to manufacturers be placed, so slow times seem likely to continue for the nation's factories.

With the recent ups and down for mortgage rates, activity for mortgages continues to wax and wane. The Mortgage Bankers Association of America noted that there was a 5.2% increase in applications placed in the week ending October 4; with that week seeing a decline in rates, applications for refinancing powered higher by 9.8%, but those for purchase-money mortgages dropped back by 0.9% for the week. With mortgage rates likely headed higher again next week, we'll probably see a corresponding drop in refi activity.

With the shift in investor stances this week, we do expect to see mortgage rates kick a little higher again next week. As of the close of business Friday, it looks to us like we'll see about a 5-6 basis point increase in the conforming 30-year FRM reported by Freddie Mac next Thursday morning, just about enough to erase this week's slide.

For an outlook for mortgage rates that carries until the early stages of the holiday season, check out our latest Two-Month Forecast.

See our mid-year review of our 2019 Outlook , where we provide updates to our speculations for ten topics that are in and around housing and mortgage markets.

For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".

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