What Powell Did That No One is Talking About | Guest Post
As recently as 30 days ago, the financial markets hung onto the hope of three rate cuts in 2024 starting in June with a zero percent chance there would be no rate cuts this year. Today as we absorb soaring employer costs, a lack of progress in fighting inflation and a resilient economy, projections for Fed Rate Cuts have become, well, less hopeful. In fact, today there is a 20 percent probability that no rate cuts will happen in 2024 at all. Now, I never win in Las Vegas and certainly wouldn’t win at the ‘guess when the Fed will start cutting rates’ game, but I do read a lot and watch the data. Today the data is less clear and often contradictory. But one thing is clear, Powell’s statement that “there has been a lack of further progress towards the Committee’s 2 percent inflation objective” seems like an understatement.
Since October 2022, month-over-month inflation has been rising, increasing from a low 0.1 percent to a heightened 0.4 percent as of March 2024. Annual inflation per the Consumer Price Index (CPI) hit 3.5 percent. These increases were driven primarily by shelter and energy costs with energy rising 1.1 percent after increasing 2.3 percent in February, while shelter costs were higher by 0.4 percent on the month and up 5.7 percent from a year ago. Core inflation, which strips out volatile food and energy, remained stuck at 3.8 percent showing no progress at all as inflation stays firmly in the 3 percent range.
If we consider the Fed’s preferred measure of inflation, the just-released Personal Consumption Expenditures Index (PCE), inflation shows few signs of letting up. Month-over-month core and headline were both up 0.3 percent with the annual Core PCE stuck at 2.8 percent. There are reporters who will highlight that this is in the 2 percent range, but the lack of progress is significant.
The biggest uphill battle in the fight against inflation is labor. Twice as many jobs were created last month than expected, we had the lowest level of initial jobless claims, i.e., people filing for unemployment, in 9 weeks and a spike in the employment cost index fueled by accelerating wage growth. Yet, contradictory data per the jolts report shows job openings fell to a 3-year low with quit rates dropping to their lowest level since 2018 implying a softening job market.
Strong job security and wage growth supports strong consumer spending, up 0.8 percent over last month, which puts upward pressure on prices and the need for higher wages. Now that the pandemic supply chain has been resolved, this wage spiral will be sludge in reducing inflation. By reducing the Fed Rate too early, Powell risks creating even more demand, thereby further increasing inflation.
So, if Powell’s three rate cuts are fading, is it just a wait-and-see? Well, yes and no. Another tool the Fed has is Quantitative Easing and Tightening. Made popular by Fed Chair Bernanke in 2008, quantitative easing is the Fed’s large-scale asset purchase of long-term treasuries and mortgage-backed securities. Massive buying of these longer-term securities not only infuses liquidity into the market, but also reduces supply, driving up bond prices, which lowers yields, or interest rates. This is basic supply and demand economics. You are going to start hearing more and more about Quantitative Tightening in the news and I want you to be ready to know what it does and what it means for your clients.
Powell used Quantitative Easing (QE) three times during the pandemic, flooding the market with liquidity and dropping long-term interest rates to historic lows, also driving the Fed’s balance sheet up to almost $9 trillion. Since June 2022, the Fed has been working to slow the economy by unwinding their massive amount of bond holdings through Quantitative Tightening (QT). Rather than actively selling bonds to the market, the Fed takes a more passive approach when tightening, allowing a predetermined amount of bonds to roll off its balance sheet as they mature. By simply not repurchasing, they are effectively allowing more supply to remain in the market driving down bond prices and increasing yields, or interest rates. They started the process by letting $47.5 billion worth of assets roll off the balance sheet every month for three months, then stepped it up in September to $95 billion, $60 billion of which is in treasuries and $35 billion in mortgage-backed securities. Now, this hasn’t been the only reason mortgage rates have been higher since then but does play a significant role.
While everyone is talking about the Fed Rate, I’m starting to watch what is happening with Quantitative Tightening. Powell has kept the federal funds rate at 5-1/4 to 5-1/2 percent during the May FOMC statement. Additionally, he announced beginning in June, the committee will slow the pace of quantitative tightening, or runoff, by reducing the monthly redemption cap from $60 billion a month to $25 billion. I.e. the Fed is allowing $35 billion more in purchases per month. This reduction in quantitative tightening will help the bond market and slowly lower the 10-year treasury and mortgage rates despite the Fed Rate staying higher for longer. While I am not ready to say rates are coming down yet, QT and as well as the premium risk spread between the 10-year treasury and the 30-year fixed mortgage rate will have more of an impact on dropping mortgage rates than the Fed Rate.
As a side note, Powell kept the mortgage-backed securities (MBS) cap at $35 billion, reinvesting any principal payments in excess of this cap. This is somewhat meaningless given the current slump in home sales and mortgage originations.
Speaking of home sales… the 30-year fixed mortgage rate hit a 7.5 percent high three times during the month of April. It’s no surprise then that mortgage purchase applications remained historically low throughout the month, only beaten by lower application data in October 2023 when rates hit 8 percent. Yet, DMAR’s 11 counties just set another record for the average closed home price at $727,700. High rates were supposed to lower prices.
Inventory also saw huge gains this month. Nationally, inventory is up 32 percent from last year and 90 percent from 2022. Here in Denver, we are up 51 percent year-over-year and up 118 percent from 2022.
With more sellers than buyers, one could predict a decline in home prices in the near future. Or, given our drop-in median days in the MLS from 11 to 8 and the increase in pendings month-over-month by 8 percent; one could also predict more sales are coming. Especially since sellers are buyers.
Personally, I am seeing more committed buyers using today’s higher interest rates to negotiate their opportunity to get into the market and stop waiting or regretting what they might have missed and instead run towards building multigenerational wealth.
Well, that’s a wrap for this month’s market update. See you next month, Nicole Rueth with the Rueth team and DMAR’s Market Trends Committee.
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