Are We Headed Toward 8% Interest Rates?
The financial markets are grappling with a whirlwind of indicators suggesting trouble ahead, even as the Fed attempts to guide the economy to a soft landing. Powell Confirmed last week they are in “no hurry to cut rates”. This seems contrary to their recent behavior but in line with recent data releases. His comments give us insight to what he will do in December. Powell “reaffirmed the Fed's commitment to reaching its 2% goal, acknowledging that the path may be uneven”.
Inflation Creeps Back
Core CPI inflation has risen for the first time in 18 months, and Core PPI inflation has increased for two consecutive months, with last month’s numbers revised higher.
September’s CPI report showed inflation at 2.4%, slightly above expectations, while Core CPI rose to 3.3%, marking its first increase since March 2023. This resurgence in inflation casts doubt on the Fed’s decision to cut rates aggressively.
Fed Chair Powell has hinted at a pause in rate cuts this December, likely to help stabilize yields and allow more time to assess the incoming data.
The Fed’s Credibility Under Scrutiny
The Fed’s messaging has been inconsistent, with statements shifting from "inflation is transitory" in 2021 to a seemingly rushed 50 basis point rate cut in September 2024. Now, Powell says there’s no hurry to cut rates further.
Investors are increasingly questioning whether the Fed acted too quickly with its recent rate cuts. Rising inflation paired with an uptick in unemployment—258,000 new claims this week, well above expectations—suggests a stagflation scenario could be unfolding.
Bond traders are investing against Fed direction. Tanking bond prices even though the Fed funds rate has been cut.
Is the Fed losing control?
Mortgage Rates, Rising Yields, and Rate Cuts
For the first time since Q4 2022, the 30-year Treasury yield has surpassed the Fed Funds rate, despite two rate cuts by the Fed this year, reducing rates from 5.50% to 4.75%.
The 30-year yield has jumped over 60 basis points in the past two months, reflecting investor skepticism about the Fed’s ability to maintain control over inflation.
Historically, when the yield curve turns positive, a recession typically follows. Yet, if the Fed can engineer a soft landing, this could be the first time the indicator proves incorrect. Will history repeat itself, or will the Fed achieve the elusive soft landing?
Although the Fed does not control long term rate cost their policy often influences investor behavior. The concern with the 10yr pricing over the Fed Funds rate is the idea that the Fed is losing control. If that scenario plays out economists believe the 10yr and 30-year yields would spike over 5.5 and 6% respectively. Driving mortgage rates towards 8%.
As yields continue to rise, mortgage rates have followed suit, with the average 30-year fixed rate climbing back above 7% last week
Mortgage-backed securities tested key support levels Friday. If they fail to hold this week, we could see a significant move lower in bond value, pushing mortgage rates 50bps or higher.
Divergence Between Stocks and Bonds
For the first time in 22 years, the 10-year Treasury yield has exceeded the S&P 500’s earnings yield, suggesting that the stock market could be overvalued. This inversion has historically preceded market corrections, raising questions about the sustainability of current equity valuations.
Notably, Warren Buffett seems to be betting on the come. He now holds more Treasuries than the Fed itself, signaling his bet on bonds being undervalued unlike many major stocks. This is a ray of hope that the bond market will calm down next year driving down mortgage rates to a more neutral level.
In summary, the Fed is caught in a precarious position: managing inflation that refuses to stay down, while navigating rising unemployment and a jittery bond market. With the December pause now on the table, the next few weeks of data could determine whether the Fed’s pivot was premature, and whether markets have already priced in a policy mistake. Expect a continued bumpy ride into the year-end.
Key Events to Watch This Week:
October Housing Starts Data (Tuesday)
Nvidia Earnings Report (Wednesday)
Philly Fed Manufacturing Index (Thursday)
October Existing Home Sales Data (Thursday)
S&P Global US Manufacturing PMI (Friday)
Michigan Consumer Sentiment Report (Friday)
Nvidia’s earnings could be pivotal for the ongoing market movement, while several Fed speakers events this week may provide more clarity on the central bank’s next moves. Their tone will likely drive the bonds in a pivotal direction.