The first few trading days of 2023 saw an improvement in rates but the party was derailed by some good news. Let's look at what happened this past week and brace for what is coming in the week ahead.
"You see I, I raise a toast to all of us who are breakin' our backs every day" - Nothing But a Good Time by Poison.
Lower Than Last Year
Long term interest rates started the year moving lower, with both mortgage-backed securities (where home loans are priced) and the 10-year Note yield posting nice gains.
This is a bit different than what happened last year as when 2022 rang in, interest rates moved higher and never looked back.
Remember, the Federal Reserve controls the Fed Funds Rate which is an overnight rate. That interest rate, along with short-term rates like the 3-month bill and 2-year Note are all higher than the 10-year Note and 30-yr Bond rates. Historically, when short-term rates remain higher than long-term rates, it means a recession is on the horizon.
Good News is Bad News
Interest rates gave up some of their nice gains to start the year in response to a much better than expected ADP Report (labor market reading).
The good news on more jobs being created was bad news for rates as markets worry the Fed will continue with higher for longer rates and eventually tip the economy into recession.
The market response to the ADP report also elevated the chance of a .50% Fed rate hike to 50/50, up from a .75% chance of a .25% hike just a day earlier.
Ultimately, the strong labor market is great for housing and the overall economy as it would ensure that any economic recession would be shallow and short-lived in nature.
December Fed Minutes Released
This week, we also got to hear what the Fed was thinking and talking about at the December Fed Meeting, where they raised rates by a smaller .50%, breaking a string of four consecutive .75% hikes.
"Participants welcomed inflation drops in October, November but concurred it would take "substantially more evidence" of progress to be confident of a sustained downward path" - December FOMC Minutes.
This line from the Minutes is encouraging that inflation has indeed peaked but is a bit worrisome the Fed will be trying to keep rates higher for longer when inflation is already coming down. Remember, it was just back in November 2021 when the Fed admittedly got it wrong regarding high inflation. Could they get it wrong this time around?
Bottom line: Long-term rates appear to have peaked, but any further improvement will be based on the incoming data. We are seeing the threat of higher inflation being offset by the elevated threat of a recession.
Next week will bring a fresh round of Fed speeches which can move interest rates. But the main event will be the Consumer Price Index (CPI) for December, where it is expected to decline to 6.7% annually from 7.1% in November. Seeing that CPI was above 9% last summer, shows inflation is indeed declining, which is good.
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