First, my apologies for not anticipating the Fed’s reversing direction after two years of
raising rates to pivot and talk about cuts. (And in my defense, a week earlier, Powell and
the fed said it was too early to speak about rate cuts.)
What does this move mean? The market interprets the Fed’s signal as evidence of ideal
conditions: falling inflation, moderate economic growth, and lower interest rates. Of
course, rate cuts could signal weakness due to tighter credit and the lagging impact of
prior rate increases … and possibly other factors, including concerns about real estate.
The consensus on the street and among investors is that we’ll have a soft landing in
2024 as inflation continues to subside and the Fed cuts rates. But remember that the
consensus coming into 2023 was that we’d have a recession and a weaker dollar and
that emerging markets would outperform. Unlike 2023, heading into 2024, there is no
projected recession. Residential values continue to be appreciated.
Continuing concerns for 2024 include the following: sticky inflation, which could motivate
rates to move higher; more economic shocks (e.g., company bankruptcy, another war,
commercial loans getting squeezed, etc.); concentration risk (62+% of capital flows into
indexes and then 30% goes into seven stocks), and signs of stagnation in the world
economy (Europe, China, Japan).
Rates and the Dollar
Yields dropped. The 10-year UST yield fell 32 bps to 3.91%. The 2-yr yield fell 27 bps to
4.44%. The 3-month yield was unchanged at 5.44%. $ 1 trillion of corporate debt is
coming due and will likely need to be refinanced by 2025, so lower rates can’t come
soon enough.
(Side note: The ratio of cash yields to stock dividends is now at the same extreme levels
as in 1998, before the dot-com bubble really accelerated. A little concerning …)
The average 30-year fixed-rate residential mortgage was 6.95% on Dec. 14th, the
lowest rate since Aug. 2022. Rates peaked in October at 7.79%. There continues to be
a lack of homes for sale, and home prices are high. We still won’t see a refinancing
boom since 90% of borrowers have mortgage rates below 5%.
The Fed and the FOMC Meeting
The Federal Open Market Committee left the Fed funds rate unchanged at 5.25% to
5.50%. (Remember, this is the rate they end to their 12 member banks. Add 3 points for
the banks/equity borrowing from the Federal Reserve member banks.) The key
projections from the Summary of Economic Projections and change from the September
projections are as follows:
1. 2023 real GDP +2.6% (projection was 2.1% in Sep.)
2. 2023 PCE inflation +2.8% (projection was 3.3% in Sep.)
3. 2023 core PCE +3.2% (projection was 3.7% in Sep.)
4. 2024 Fed funds rate 4.6% (projection was 5.1% in Sep.)
Notes: Surprisingly, only three Fed officials saw the Fed funds rate above 5% by the end
of 2024. Powell says that the Fed funds rate is “well into” restrictive territory (not just
“restrictive”). He no longer says that we need below-potential growth. He seems
focused on the risk of keeping rates too high for too long. He even admitted to
discussing when to start rate cuts. He said rates would need to be cut before inflation
reaches 2%.
Powell’s statement that rate cuts were under discussion contradicted his statement 12
days earlier that it was premature to discuss cuts. After the meeting, NY Fed President
Williams said that the Fed was not discussing rate cuts yet. Cutting rates is rare when
core inflation exceeds the unemployment rate. There’s some question as to why Powell
would make such dovish comments. Other countries are still hawkish on rates; ECB
President Lagarde said, “We should absolutely not lower our guard,” and the BOE’s
Andrew Bailey said, “There is still some way to go.” Norway increased rates.
The street and the fed funds futures market are pricing in a 50+% likelihood of the
FOMC cutting rates by the end of March 2024. The market is pricing in five to six rate
cuts between now and the end of 2024. Markets historically get ahead of themselves on
Fed policy. Mark Sprague’s conservative nature says there will be no rate cuts if inflation
doesn’t slow to the target rate. Waiting for rate cuts is not a smart play! (Yes, I just
referred to myself in the third person.)
Thoughts on the surprise announcement
So why did the Fed pivot so sharply? If I had seen it coming, I would have better
understood how to respond. The change, of course, may have been to help the
struggling housing market, to acknowledge that the labor market is loosening (jobless
claims rising, vacancies declining), to provide relief after the bond market rout (like
regional banks), out of concerns about commercial loan renewals, etc. Of course, there
is a risk of fueling a market melt-up in stocks.
The argument to loosen policy goes like this: inflation has dropped significantly (core
PCE has averaged 2.5% over the last six months); the Fed funds rate is much higher
than it was a year ago, and with lower inflation, the real Fed funds rate is higher; the
labor market is loosening; economic growth is slowing from Q3 to Q4; banks are
tightening lending standards; lag effects from rate increases could still be impacting the
economy; inflation is coming down faster than expected and is projected to be 2.4% by
the end of next year.
On the other hand, part of the decrease in inflation is from the healing of the supply
chain and more workers being available. That may be winding down. There is fear that
easing financial conditions (lower yields, higher stock prices, and a weaker dollar) may
also make it harder for the FOMC to actually lower rates. Powell has not pushed back
against financial easing. In addition, growth could be too strong to support expected
cuts.
The Fed has focused on beating high inflation for the past two years. Now, they are
concerned with both inflation and employment (a balanced approach). The Fed must
balance the risk of moving too slowly to lower rates and causing a recession (and high
unemployment) versus the risk of lowering rates too fast and allowing inflation to return.
A slower economy or lower inflation would allow the Fed to cut rates. (The Fed has
done a phenomenal job of raising rates without triggering a recession.)
Inflation is falling faster than the Fed expected. Core PCE is 2.5% annualized over the
past six months. This is allowing the FOMC to pivot.
Economists and analysts are split on the Feds’ announcement. Some still believe that
the risk of inflation is high. Rates are comparatively high, and the full effect of past rate
increases has not been felt yet; housing and manufacturing are struggling; leading
indicators are down over the past six months. But there are strong arguments for
avoiding a recession: unemployment is still very low; jobless claims are low; the stock
market is rallying. (As much as it hurts me to say this, it’s not just about real estate.)
So, what is the take-away message? The Fed has signaled they’re open to cuts but
have not committed to such. Rate cuts and residential values are separate economic
issues. Residential values are not coming down, and we’re seeing high single-digit
appreciation in all of our Texas metros. Nothing in the economy suggests the Fed needs
to be in a hurry to cut interest rates in 2024. In a soft-landing scenario, the Fed only
needs to trim rates in response to further easing of inflation pressures, just enough to
maintain tight policy without loosening it. So, don’t expect rate cuts till the Feds’ inflation
targets are met. Expectations are that we may see cuts in the latter half of the year.
2024 will have better residential sales volume than 2023.
I still have concerns about commercial loans. In real estate, offices, and retail centers
are questionable.
Lastly, when many of you saw the announcement about potential rate cuts, the
immediate comment was, “Of course, it’s an election year.” Many people swear
mortgage rates go down before or during an election year, but it’s really hit-and-miss
when looking at the past thirteen elections. This chart shows the 30-year fixed rate
since 1971 (FRED St Louis)
Feel free to contact your Independence Title Business Development Rep if you have
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