February 8th, 2016 3:52 PM by Chris Styner
February 8, 2016 by Michael Kraus
Foreign stocks got hammered in the overnight session last night, and that momentum has carried into U.S. equity markets this morning, leading to a sharp sell-off. Once again Treasuries are benefiting as a safe haven investment, and are rallying this morning. The yield on 10-year Treasuries is around 1.77% as of writing, which looks to be the lowest yield we’ve seen in more than a year. Mortgage backed securities, which typically move with Treasuries, are also rallying this morning, and mortgage rates continue to fall. Last week Freddie Mac’s Primary Mortgage Market Survey showed the average rate on a 30-year fixed-rate mortgage with 0.6 points was 3.72%, the lowest reading since April of 2015. Rates have declined since the beginning of the year, when the Freddie Mac showed the average 30-year rate to be 3.97%.
As always, you need to be aware that the Freddie Mac surveys are collected early in the week (the results are issued on Thursday), and don’t reflect events that occurred at the end of the week. Unless there is a big bounce back in stocks this week (and the accompanying sell-off in bonds), we should see even lower rates this week.
Last week, in many ways, was just more of the same. Further questions were raised about the health of the global economy. Stocks rallied midweek, only to sell off again at the end of the week, ending up more or less where they started. Oil prices followed pretty much the same arc. 10-year yields were consistently around 1.90%, give or take a couple of basis points.
Last week’s domestic economic data also continued trends seen in prior weeks/months. Manufacturing reports showed weakness, and that weakness might be making its way into the service sector, as ISM’s non-manufacturing Survey showed weakness. Most measures of inflation remained subdued.
The most anticipated bit of news last week was January’s employment numbers, which were mixed. The headline number came in under expectations, but within the range of expected outcomes. 151,000 jobs were added in January, compared with the expectation of 188,000 jobs gained. December’s headline number was revised down from +292,000 jobs to +262,000 jobs. However, the underlying data showed more strength than the headlines. The unemployment rate fell from 5.0% to 4.9%. The workforce participation rate ticked up from 62.6% to 62.7%. Average hourly earnings were up 0.5% from last month, and are up 2.5% on a year-over-year basis.
So what to make of all this? Good question, and a good segue into the next section.
So the question is, how will all of what’s going on impact the Fed, and will it cause them to slow the pace of rate hikes moving forward, or not? Last week we heard from several Fed members (Lael Brainerd – dove, William Dudley – dove, and Loretta Mester – hawk), and they all noted the risks that global headwinds pose to the domestic economy, and I think we could characterize all their comments as being somewhat more dovish than anticipated. Some Fed members had indicated at the end of 2015 that it would likely be appropriate to hike 3-4 times over the course of 2016. We’ll see if recent developments will force them to back away from that plan. We hear from Janet Yellen twice this week, so perhaps she will shed some light on what the Fed is thinking.
For what it’s worth, the Fed Funds futures show just a 4% implied probability of a hike at the next Fed meeting in March. Looking as far forward as December, the futures only show a 25% chance of a hike. The markets are clearly not buying the idea of 3-4 hikes this year.
As evidenced by yesterday’s game, the markets are not always correct. Tim Duy, from last Friday “Solid Jobs Report Keeps Fed in Play”:
“Bottom Line: This jobs report complicates the Fed’s decision making process. They are stuck with instability in the financial markets as the economy reaches full employment. They are concerned that in the absence of temporary factors, inflation will quickly jump higher if the economy continues on this trajectory. While they would like unemployment to settle somewhat below NAIRU* to eliminate lingering underemployment, they don’t want it to settle far below NAIRU. They don’t believe they can easily tap the breaks to lift unemployment higher. Recession is almost guaranteed to follow. Hence they would like to be able to rates rates gradually to feel their way around the darkness in which the true value of NAIRU lies. They fear that if they delay additional tightening, they will pass the point of no return in which they are forced to abandon their doctrine of gradualism. The Fed’s policy challenge just became a little bit harder today.”
I think it is also important to remember that the Fed is always concerned with its own credibility. They do not want to be seen as easily swayed by recency bias, and they want to be perceived as having a plan. If they were to reverse course so quickly after raising rates, it could be seen as lowering confidence in the Fed. This isn’t a particularly good reason to take a course of action, but it is a factor.
*NAIRU is the non-accelerating inflation rate of unemployment. Basically, if unemployment falls below this level, inflation is expected to increase. Depending upon the economist you prefer to read, this number is believed to be somewhere between 5-6%, and likely fluctuates depending upon a host of factors.
Yeah, it is. Mortgage rates are about 40 basis points higher than record lows. Is it possible rates continue to fall? Sure it is. It’s also possible that the market rebounds and they return to the levels that we saw around the beginning of the year. I realize that’s not particularly insightful, but I think it illustrates the point: anything could happen, and anyone who tells you they know what is going to happen should be suspect. As recently as two months ago, the members of the Federal Reserve, ostensibly some of our best and brightest, thought that we could see 3 or 4 rate hikes this year. That seems really unlikely now.
If you’re trying to time the market, you’re likely to fail. If you’re ready for a new mortgage, rates are very advantageous right now. If you’re seriously considering buying a home or refinancing, but aren’t quite ready to make the leap, you may want to accelerate your timeline. The markets are very volatile, and rates are subject to change quickly.