In the just-released FOMC statement, the Fed announced a 0.25% hike in the Fed Funds rate (+25bps). This was in line with the forward guidance provided by Chair Powell and matched the market’s consensus expectation.
After the previous 50bps hike in December and four 75bps rate hikes prior to that, this marks the next step the Fed is taking to slow down the pace of their inflation-fighting campaign. Today’s rate hike puts the Fed funds range at 4.50% to 4.75%. Current market expectations have the terminal rate in this cycle going to 5%, Fed guidance from the December dot plots was implying 5.25%. We do not get fresh dot plots at today’s meeting.
This next smaller hike was a result of slowing economic growth and a continued decline in several key inflation measures. Not the least of which was yesterday’s softer 4Q22 Employment Cost Index reading. This inflation subcomponent is getting more attention due to its measurement on wages and the Fed’s focus on that inflation pressure point.
While the Fed can make a case that economic readings are moving in the right direction, but still far from showing a collapse, there is still uncertainty ahead. At odds with that, the steep yield curve inversion shows bond market investors are anticipating a recession soon. Complicating these different outlooks is the re-opening of the Chinese economy and the fresh source of inflation pressure that could put into the global economic mix.
Until the next FOMC meeting on March 22, the markets will get two more months of inflation, jobs, and economic activity indicators. And without a re-fresh of the dot plots today, the market will also have to wait to see how the Fed’s expectations for the terminal rate are changing. Will it be greater than 5%? Does the Fed still expect to hold at the terminal rate into 2024? Will the onset of a recession in 2023 change the Fed’s course?
Keep in mind, bond market investors want to be positioned today for where term rates will be about six months forward. Today’s historically steep yield curve inversion is a direct reflection of this. By bidding down the yield of term rates (those bonds that mature in longer than 2 years’ time), bond investors are telling us they expect a recession will force the Fed to abandon their current guidance and have to start cutting the Fed funds rate.
As new data reveals the accuracy of that assessment, bond investors will quickly react. And that may alter the assumed downward path that borrowers are anticipating for mortgage rates over the next six months, both in speed and degree.
What Do Borrowers Do Now?
Originators should explain to borrowers who want to finance the purchase of a home that the current mortgage rate market remains exposed to a greater than typical level of uncertainty. Since November, mortgage rates have benefitted greatly from the recent decline in inflation measures; rates are already significantly lower than they were.
On top of that, the real estate market is retreating from the highest levels of unaffordability seen over the summer, but available inventory is still tight and will remain so for years to come. There is no market crash expected like we saw during the 2008 financial crisis on the horizon.
Rates falling further may still be on the horizon but will be beyond today’s timing opportunity to find a suitable home for customers searching in a marketplace with historically low inventory.
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