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Volatility Reigns But Economy Too Fragile For Latest Rate Spike


This morning, Friday, February 11, I decided to write this blog about why the spike in interest rates on Thursday was way overdone, as the underlying economy was weakening, not strengthening. Before I finished writing, the fixed income markets had reversed most of Thursday’s long-term rate spike and some on the shorter end. Looks to us like this was due to short covering as a result of the White House’s announcement that a Russian invasion of the Ukraine was near. Markets, of course, react to much more than the underlying economics, as is the case here. Nevertheless, those economics remain the anchor. And, regardless of the market’s volatility, this blog explores why the anchor, the underlying economics, won’t support rising rates and why we think they will go lower once the scare about Fed hawkishness abates.

The Rate Spike

Inflation ran hotter in January than expected, up +0.6% M/M and now at 7.5% Y/Y. The consensus was +0.4%. Financial markets, especially in fixed income land, are no longer taking their cues from the state of, or prospects for, the economy. Rather, they are looking at what course the Fed might take regarding the magnitude of the pre-announced tightening cycle. So, the hotter than expected CPI numbers played to the markets’ fears. Making matters worse and amplifying market fears was a statement by St. Louis Fed President James Bullard, perhaps the Fed’s biggest hawk. He called for a rise in the Fed’s benchmark lending rate (Fed Funds), currently pegged at 0% – 0.25%, to jump to 1.00% by July, implying at least one 50 basis point (0.50 pct. points) increase at one of the two upcoming Fed meetings prior to July. Markets had penned in a much slower rise and also assumed that such rate increases would be data dependent as reiterated time and again by Fed Chair Powell. 

Four positions on the Federal Open Market Committee (FOMC), the Fed’s policy and rate setting committee, rotate on an annual basis, and this year, Bullard is a voting member. The fixed-income markets, motivated by the fear that the Fed would be much more hawkish than markets had priced in, reacted violently, and interest rates spiked on Thursday. The 2-yr Treasury Note spiked 25 basis points (.25 pct. points), the largest one-day increase since the financial crisis in 2009. The 10-Yr Treasury Note, which is the benchmark for mortgage rates, spiked 10 basis points to 2.03%. That instrument began February at 1.77% and was 1.34% in early December. 

[Note: The resulting rise in mortgage interest rates can’t be good for housing affordability and negatively impacts lower-and-middle income groups. In addition, if the Fed begins to shed the Mortgage-Backed Securities in its massive portfolio, as it has suggested it will do, mortgage rates will feel even more upward pressure.]

Markets occasionally react violently, especially when new information, not…


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