As predicted, interest rates are now increasing. Interest rates retreated from 2022 peaks but ticked up last week as the Ukraine invasion by Russia escalates and grows more uncertain. However, there were other big developments here at home that erased a good portion of the rate improvement.
Let’s break down what happened last week as we prepare for an important Fed meeting on March 16th. The Fed will hike its key policy rate for the first time since 2018, but mortgage rates aren’t waiting to move higher. By the end of last week, they were as high as they’ve been in nearly 3 years.
Our trusted mortgage banker and adviser, Elise Leve of Citizens Bank (https://www.linkedin.com/in/eliseleve/) has helped us breakdown the details.
1.) Ukraine Invasion Market Reaction
The Ukraine/Russian conflict has escalated, and the outcome remains highly uncertain. No one knows if, when, and how this will end. When the world experiences tense geopolitical moments, it drives what is called a “safe-haven” trade into the relative safety of the US Dollar and the US-denominated assets like Treasuries and mortgage-backed securities (MBS).
Last Monday and Tuesday interest rates moved sharply lower, with the 10-yr Note declining from 2.00% to touching 1.69%. MBSs also improved nicely but the gains were not in lockstep with the ultra-safe haven of the Treasury market. Meaning, when the world is highly uncertain, Treasury rates improve faster and further than home loan rates.
The longer this conflict continues the longer we should expect rates to remain near or lower than current levels as the situation puts a bid or support under the bond market.
2.) Fed Chair Powell Testifies Before Congress
Hump Day (Wednesday) was bad for bonds/rates which gave up half a sizable portion of their multi-day rate improvements. The main catalyst was Fed Chair Powell, who provided his semi-annual testimony before Congress.
“Reducing our balance sheet will commence after the process of raising interest rates has begun and will proceed in a predictable manner primarily through adjustments to reinvestments.” Fed Chair Jerome Powell prepared testimony on 3/2/22.
This line reiterates the Fed’s desire to remove MBSs from their balance sheet. The Fed currently has $2.7T of MBSs on its books. If the economy remains strong and can absorb multiple Fed rate hikes, then the Fed will try to become a seller of MBSs. The MBS market didn’t like these words despite all the uncertainty in Ukraine and home loan rates shot higher in response.
“The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain. Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.”
Here, the Fed is telling us the uncertainty in Ukraine could lead to fewer rate hikes. Stocks liked it and soared higher, at the expense of bonds and rates.
Lastly, the Fed essentially told Congress that it expects a .25% hike in a couple of weeks. This removed the uncertainty that the Fed may go with a .50% hike. Stocks liked this and bonds did not. The next FOMC Meeting is March 16th.
3.) Soaring Oil Prices
Oil touched $130 a barrel on March 6th, a 13 year high, before returning to the $110 range. If there was ever a time to have high prices “transitory”, let’s all hope this dramatic increase in oil prices proves to be short-lived. High energy prices are an economic killer. It is already weighing on consumer sentiment, and should it continue, it will weigh on consumer spending, which makes up two-thirds of our economic growth.
The Federal Reserve will be factoring in the high oil price and its economic impact as they consider rate hikes and ultimately shrinking their balance sheet.
Fed rate hikes are designed to slow demand and thus lower prices. If the consumer retreats on their own due to higher energy prices, the Fed may not be able to hike as aggressively as they intended when the year began.
Outlook
Almost all economic reports take a back seat to the elephant in the room, Russia/Ukraine. If this story gets worse, we should expect rates to improve again. The opposite is true. Expect volatility with stocks, bonds, and rates to continue.
The mortgage market has long since moved on from caring about the expected rate hike. It was a foregone conclusion by mid January. Rather, mortgage rates have been responding to a perfect storm of problems that have combined to push the average 30yr fixed rate higher at its fastest pace since 2013.
Bottom line, everything hinges on inflation right now. That was already true before Ukraine, and now it’s painfully true. Inflation is the Fed’s key consideration in making changes that have pushed rates higher. From here, markets will be paying even closer attention to oil prices and inflation metrics. They’ll also be listening intently on March 16th as Fed Chair Powell comments on whether the Fed’s reaction function might change again in light of the commodity price surge.
If you, a family member, or a friend is considering a mortgage, now is a great time as rates remain just beneath the 2022 peaks.
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