Federal Reserve Pushing Rates Up
Updated. EXERCISE CAUTION in all home and market investments for the next 60 days! Many data points released on November 24 show the Federal Reserve has room to become more aggressive in fighting inflation. With the Federal Reserve pushing rates up now, their previous rate forecast looks incompetent. The Federal Reserve ignored the broad evaluations of top economists of every stripe. While one set of monthly data will not decide everything, indicators point to new flexibility for the Fed. Aggressive action might lead to retracement in the stock market. Retracement for the stock market could mean a fall of 5,000 points on the Nasdaq and 6,000 to 10,000 points on the Dow (20,000+on Bitcoin) over the next 6-12 months. Don’t panic yet, but start moderating your investments and get more cautious in buying a home right now. We still target the spring, but continue to be cautious in that forecast.
The Federal Reserve Bank began slowing asset purchases in November and expects to stop purchases totally by mid-2022 or earlier. At that point, many indicate the Federal Reserve will need to raise interest rates. It will also sell off its $8.5 TRILLION in interest rate driven assets (Treasury bonds and mortgage loans in the form of MBS). What is the Federal Reserve rate forecast once that begins? The Fed itself won’t make a prediction. However, two former Fed governors did just that in interviews in November. Others do have a prediction: the summary of economic projections to be released this month, in which officials show their expectations for the future, likely will point to interest rate hikes pulled forward into 2022. Markets currently expect the Fed to enact at least two quarter-percentage point increases next year.
So why did the market hit new all-time highs before year-end 2021? The Fed hasn’t stopped printing money. The money supply increased by $250 billion in just November. 2021 continues to be the Fed which doesn’t stop raining money.
Powell Throwing in the Towel?
Did Chairman Jerome Powell throw in the towel in his weasel word of “transitory” to describe inflation and the Fed ignoring the mandate of price stability? As predicted a while ago and noted below, the Fed has fallen way behind inflation and its mandate by printing money in vast quantities to keep rates artificially low. It almost single-handedly has caused inflated asset prices in stocks, housing, cryptocurrency, art, food and other areas.
On November 30, Powell suggested that price increases are lasting longer and becoming broader. He didn’t directly say that the pace of reductions in asset purchases would speed up, or that interest rates would rise sooner than than previously expected. But the inference is that inflation is such that the next FOMC meeting could see another decrease to the monthly size of asset buys to finish the program sooner. Also, the FOMC’s forecasts in the summary of economic projections could pull the timing of rate hikes forward.
Powell did say that “The threat of persistently higher inflation has grown.” He later said that asset purchases might be, “wrapping up, perhaps, a few months sooner.”
In speaking of inflation, Powell said it might be time to “retire transitory” as how the Fed describes the forces currently affecting price increases. The measures for housing costs continues to soar. This makes up a large portion of the total inflation measure. Evidencing failure by the Fed, this foretells continued high inflation, perhaps at the 6-8% or more level, well into 2022.
El-Erian Speaks
One of the best known, most respected economists and money managers, Mohamed El-Erian, weighed in on Fed Chairman Powells’ reversal on inflation. He is President of Queens’ College, Cambridge and chief economic adviser at Allianz, the corporate parent of PIMCO where he was CEO and co-chief investment officer (2007–2014). He was chair of President Obama’s Global Development Council (2012–17).
According to El-Erian, Powell’s ‘Transitory’ Retreat Is Just the Beginning.
The Fed chair finally retired a phrase that had become increasingly meaningless. Now he has to manage the communication and policy challenges of the late wake-up call on inflation. By finally retiring the word “transitory,” Powell did more than finally correct a gross mis-characterization of inflation that he was wedded to for way too long. He also put the spotlight on inflation as a major risk to the economy and financial markets. The Fed’s policy responses have been lagging realities. The catch-up process – and a rapid one is required given the delays so far – could destabilize markets and the economy. It didn’t have to be this way.
For months, Powell asserted that inflation was transitory. Rather than revisit in a timely basis his assertion in the face of ample evidence to the contrary, he adopted an ever-more elastic concept of the word that favored longer and arbitrary time periods at the expense of economic analytical rigor. That ensured that the Fed continued with massive monthly purchases of market securities at a time when the economy was doing just fine, the housing market was red hot, and the liquidity-fueled “everything rally” in financial assets was showing growing signs of excessive risk-taking.
Ex-Fed Officials Dudley, Lacker See Rates Rising to at Least 3% (Not Mortgage Rates)
Former New York Fed president Dudley sees peak at 3% to 4%
Ex-Richmond Fed leader Lacker says 3.5% to 4% is ‘plausible’
The Federal Reserve will probably have to raise its target for the federal funds rate to at least 3% to try to keep inflation in check, two former Fed Reserve Bank presidents said. Ex-New York Fed leader William Dudley and former Richmond Fed President Jeffrey Lacker made the comments in separate interviews. These two ex-Federal Reserve presidents have their own Federal Reserve Rate Forecasts which show more caution than the current Federal Reserve voting members.
The forecast here is the lowest rate, the overnight rate, that the Fed targets. The current rate set by the Fed is 0%. So that’s a jump of 3% or more in a year. What does this mean for interest rates on mortgages? Currently, the mortgage rates are about 3% higher than the overnight rate. So these former Fed officials predict mortgage rates in the 6-7% range. We agree that the current excess spending by the federal government causes the high inflation seen today and will lead to increased rates. If the “Build Back Better” plan passes, mortgage interest rates won’t pause at 6-7%. They likely will continue towards 10% in the late 2023 to 2025 time frame.
Before that time, home prices would start falling. If rates head towards 10%, the likely decline in home prices would exceed 25-30%. For example, a $200,000 mortgage today at 3% requires a monthly payment of $843 principal and interest. At a 6% interest rate, the same payment only buys a $140,000 mortgage, a decline of 30%. At a 9% rate, the same payment only buys a $105,000 mortgage, a decline of almost 50%.
Federal Reserve Tapering
The Federal Reserve Open Market Committee (FOMC) met on November 2-3. Fed policymakers announced its start to taper in November 2021. It will drop purchases by $15 billion in November, $30 billion in December and scaling down further over time. The Federal Reserve has had a program of buying $120 billion of assets per month for years. Assets purchased include government debt (Treasuries) and Mortgage Backed Securities (MBS). What is Federal Reserve tapering and what will be the effects? The Fed has strayed way off base from its mandates under the law
First, the asset purchases. Purchasing Treasuries by the Federal Reserve Bank (Fed) serves multiple purposes. It creates demand for the massive government over-spending in recent years. And it keeps interest rates artificially low. Artificially low rates lower the interest cost to the federal government. A ripple effect keeps interest rates low across the board (car loans, student loans, etc). Buying MBS creates demand for re-sale of mortgage loans. Few loans taken out for mortgages remain with the original lender. Most all are re-sold to Fannie Mae, Freddie Mac, or put into a big pool known as an MBS. Like buying Treasuries, it keeps rates artificially low, but buying MBS concentrates the low rates in the mortgage area.
The Fed targets buying $120 billion of assets each month. Two-thirds of the buying goes for Treasuries and the balance for MBS securities. The Fed currently holds about $8.5 trillion of these assets which were bought over the past decade with about half bought in the last two years.
Tapering Timeline
Tapering will be a reduction in the amount bought each month. This means the Fed will still be a buyer. It just wont be buying as much. The market already has reacted by pushing the interest rate on the ten year Treasury up by about 1/2%, from 1.20% to 1.65%. Mortgage rates have followed upwards, jumping more than that 1/2%. Mortgage rates over 3.25% have become the norm, up from 2 5/8% to 2.75% earlier.
The Fed will immediately pare back purchases in November 2021. Previous remarks by members of the FOMC indicate finishing the tapering by mid-2022. An 8-month time frame means a cut, in regular increments, of $15 billion per month. That matches the November 3 announcement.
Tapering Effects and Considerations
Since the Fed meets every 6 weeks, expect the Fed to evaluate the effects in December and January meetings before making any changes. If the effects are very negative, expect the tapering to slow. If effects are minimal, expect the tapering to possibly accelerate. Pick up a copy of Winning Mortgage, Winning Home for more insights.
Regardless, we look for rates to continue the slow march upwards. This will slow home purchases and severely impact refinancing. By the end of the first quarter of 2022, cut-throat competition for buying houses will have mostly disappeared. Prices will level or start coming down. This will be a good sign for those who follow Winning Mortgage, Winning Home and our Advantageous Purchase forecast.
Remember, it will cost you more to overpay now than to have a slightly higher interest rate mortgage. Don’t overpay. Once the Federal Reserve tapering ends (say mid-2022), the Fed has indicated it will start looking at a straight increase in interest rates. It will also need to determine how fast to sell off the $8.5 trillion of assets it currently owns. This may cause greater upward pressure on rates in the 3rd and 4th quarter of 2022. Once the Fed goes from BUYING $6 billion a day to SELLING $6 billion a day, the effect on rates becomes more pronounced. Who will be the new buyers that can buy that much debt?
Interest Rate Hike Predictions
According to Standard & Poors, a giant economic tracking firm, chances of the Fed beginning to raise interest rates in June 2022 spiked. In September 2021, only about 16% of Fed watching experts expected a hike by June 2022. That prediction of the Fed raising interest rates in its June 2022 meeting soared to 58% in late October 2021. Coincidentally or not, that matches the expected end of tapering? Almost 20% now predict a rate hike as early as March 2022, up from 1 in 50 expecting such a hike.
Government Spending
The scenario above assumes the current proposal to spend $2-6 trillion in the “Build Back Better” plan is NOT passed. The real cost of that plan is much higher. The Fed will need to be involved in even greater asset purchases to prevent a spike in inflation over 10% by the 4th quarter of 2022 if passed. If the Fed stops buying debt and goes to selling debt in the face of new government debt issued at a rate of $3-5 billion more per day, how will markets react? The Fed may not have the ability to prevent that spike. That would be a swing of more than $15 billion PER DAY (stop $120B purchases = $6 Billion per day, unwind $120B portfolio = $6 Billion per day, new debt = $3-5 Billion per day).
Think inflation is high now, can’t buy anything due to supply chain issues, and prices keep going up on everything? Just wait until this spending plan passes and find out what real inflation, high interest rates, and shortages look like.
Alternate Outcomes
Despite the historical patterns where government spending and Fed rate management seen today mirrors past periods, alternate outcomes, however unlikely, may exist. The economy could experience what is termed a “Goldilocks” recovery where everything planned by the government bureaucrats goes as they plan. The job market booms, stocks go higher, inflation resolves itself to a low, sustainable rate. Or, the combination of government intervention causes a major meltdown and recession as happened in 2008. At present, most policies point to the consequences of the 2008 run up, but not all do.
One thing which has emerged with new appointments to the CFPB, FHFA, DOJ, HHS, HUD and other government agencies is an opinion that that all lenders, landlords, and businesses are crooks. Or they would be except for the superpowers and daring rescue of consumers by these agencies. Only government is good reflects the new attitude of the current administration this year.
As the next 12 months plays out, where do you stand? Will government save the day? How are they doing so far?