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Interest Rates are Like the Weather? Or Like the Signs of the Zodiac?

By Rob Chrisman, Senior Advisor

“The only function of economic forecasting is to make astrology look respectable” (John Kenneth Galbraith).” Lenders and loan originators who listened to, and relied on, predictions, and were hoping for lower rates as 2023 moved along, have been sorely disappointed. We’re more than halfway through the year and not only have mortgage rates not gone down but have risen to the levels we gasped at earlier this year. Seven percent!? Loan officers who believed predictions and based on them, banked on their business increasing into the summer are re-thinking their business model. What happened?

“Prediction is very difficult, especially about the future.” Whether you attribute that statement to physicist Niels Bohr or to baseball player Yogi Berra, it is true. And especially true when it comes to the bond markets, and therefore mortgage rates, given the number of variables and global “moving pieces” that have an impact on the rates shown to borrowers. The general reason why rates have moved in the opposite direction that the “experts” were prophesizing is that the U.S. economy has been much stronger and more resilient than expected. Strong economies foster higher rates, slow economies lower rates.

The Fed raised its policy rate band for a tenth straight time in May, by a quarter point to 5-5.25 percent. They decided on no change in June, to assess the impact that higher rates were having on the economy and banking system but forecast two additional increases this year.

Our economy is based on housing and jobs. On the housing front, homebuyer affordability has eroded for several months as prospective buyers continue to grapple with high interest rates (30-year rates are more than double what they were two years ago) and low housing inventory. But the stock prices of publicly held builders are up 40 percent this year! Helping their stock prices are a scarcity in existing housing supply, strong seasonal demand, and demographic trends supporting further market strength. The national median home price remains nearly 40 percent higher than it was three years ago.

In terms of jobs, the most recent numbers which were announced July 7 showed that the U.S. labor market added 209,000 jobs in June, while the unemployment rate ticked down to 3.6 percent. The number is slightly below economists’ expectations of 225,000 jobs. It is also a slowdown from the prior month’s figures: May was revised down by 33,000 to 306,000 and April by 77,000 to 217,000. The June job gains came alongside steady wage growth. Average hourly earnings, a gauge of wage growth, rose by 0.4 percent in June (the same pace as May, which was revised slightly higher).

One can slice and dice the employment figures however one sees fit, but the bottom line is that employers continue to add a healthy number of new jobs, helping keep the economy on a solid footing. The Federal Reserve has a close eye on labor market developments which have largely pointed to a hot jobs market that has remained resilient despite aggressive efforts to cool it down. High demand for workers usually fuels stronger wage growth and, in turn, inflation. And it is the continued fear of higher-than desired inflation that has moved rates and kept them higher than some thought.

“Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening….” So spoke Peter Lynch, well known for his work with the Magellan Funds many years ago. Sure enough, as we’ve moved through 2023 earlier predictions have been incorrect. Economic data has all but extinguished doubt about a Fed interest-rate increase at the end of July. And so, some have turned their attention to the central bank’s September meeting, which, at this point, is a coin toss between leaving short-term rates alone or raising them further. Currently the economy is in good shape if you go by the jobs and housing figures, though inflation is still stubbornly high.

Many believe that what is currently happening is that inflation will moderate in a way that will take pressure off the Fed after this month. But some are hedging their bets by saying that the Fed will keep a fall hike alive to prevent the market from pricing in cuts. This is one way it is achieving tighter financial conditions. It’s risky to position for Fed rate cuts next year in response to an economic slowdown even if one expects them.

“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” The last revision to the first quarter Gross Domestic Product (GDP) showed a shocking upward revision to 2.00 percent from a previously reported 1.3 percent. This has dramatically removed the fear of recession in the near-term, at least for now. This has also elevated the chance of a Fed rate hike at the end of July to nearly 100 percent.

Going forward, the economic data will be important to track, as always, to see if the economy remains as strong as it was in the first quarter. Part of the bump in consumer spending was in response to an 8.7 percent increase in social security benefits, which are adjusted for higher inflation. Housing and used-car sectors are expected to help push down the core index, but progress could then stall so long as the economy doesn’t weaken.

Like the weather, the economy will do what the economy will do. Lenders and loan officers cannot determine the direction of the bond market, but they can prepare for changes in direction or make their businesses immune from interest rate movements by focusing on products and services that their clients require. STRATMOR has seen its most successful clients not “bank” on someone’s predictions, but instead focus on hard numbers, analytics, and performance.

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