Rob Chrisman's Perspectives


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The Secondary Market’s Focus

By Rob Chrisman, Senior Advisor

Much of the lenders’ focus is on the primary markets: customer satisfaction, processing effectively, and funding loans in a cost-effective manner with the right vendor partners. But being able to sell the “finished product” at a profit is critical, otherwise all is for naught. And a key part of that is the interest rate climate, which drives volumes and products for every lender.

For the last several years the collective attention of the financial community, including lenders and their capital markets staffs, have been firmly planted on the Federal Reserve. The U.S. central bank carries out its mission through the actions of its Federal Open Market Committee (FOMC). The FOMC does not set mortgage rates, but the same factors that influence its actions also influence mortgage rates, so as 2022 wraps up and we begin 2023, it is good to know how the Fed operates and what the market is thinking about its actions. After all, its actions directly impact the interest rates that borrowers see.

We all talk about “the Fed,” but what is it? The Board of Governors of the Federal Reserve System was established as a federal government agency made up of seven members appointed by the President of the United States and confirmed by the U.S. Senate. The Chairman (currently Jerome Powell) and the Vice Chairman of the Board are also appointed by the President and confirmed by the Senate. The Federal Open Market Committee (FOMC) is made up of the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC is charged under law with overseeing open market operations, the principal tool of national monetary policy. It is the FOMC that makes financial news headlines, in recent years through Quantitative Easing and now through raising the target Fed Funds rate.

The FOMC is fully expected to deliver a 50-basis point (bp) rate hike at its December meeting. Given this move, analysts have upwardly revised the median path of the policy rate to 4.9 percent by end-2023 and continue to see the first overnight Fed Funds cut coming in 2024. Inflation has been driving the Federal Reserve’s decisions for the majority of 2022, and this focus is expected to continue into 2023. And these decisions, and the expectations of these decisions, move rates.

Throughout 2022, and into 2023, FOMC statements and the minutes from their meetings should continue to highlight elevated inflation and participants will still see the balance of risks to the upside. On balance these changes should allow Chairman Powell to justify the step down in pace while maintaining the Fed’s commitment to fighting inflation.

The Fed will now enter 2023 just 50 bp shy of where it sees the likely peak and it will seek more flexibility in its approach. In Federal Reserve statements in December and moving into 2023, we may see the verbiage “ongoing increases” with “some further increase,” intended to be interpreted as plural or singular. The Chairman will then have the opportunity in the various Q&A sessions to underscore that there is more work to be done. But in general, investors expect the Federal Reserve to stay the course in its battle to tame inflation, even as recession worries mount.

There are those who believe the U.S economy is heading for a recession. Recessions typically push interest rates lower as the demand for capital diminishes so lenders lower rates to encourage borrowing. But we’ve been hearing recession forecasts for a year now, and unemployment is still low, and the economy is churning along. Yes, the two-year Treasury yield is roughly .8 percent higher than the 10-year! Normally longer-term rates are higher than shorter-term rates, and the current pattern, known as a yield curve “inversion.” has preceded every US economic downturn of the past 50 years.

Yet recent economic data paint an upbeat picture of the state of the economy. Some are worried that solid economic data will encourage the Fed to keep pushing interest rates higher next year, after taking them from near zero to a range of 3.75 to 4 percent so far in 2022. Higher borrowing costs, in turn, are expected to heap pressure on the economy and potentially trigger a recession.

The Financial Times sums up the current situation. “The most basic signal sent by the yield curve inversion is that investors believe the Fed’s increases in short-term rates will be successful in sharply slowing inflation. The magnitude of this inversion then reflects both the dramatic pace of rate increases, and the fact that the Fed has stuck with that pace even as investors have shifted their expectations on inflation and growth…. Though the yield curve has been a reliable indicator of recession, the information conveyed by the depth and extent of the inversion is up for debate.”

A popular bet is that lenders should continue to see the Fed holding rates steady until December 2023, when it begins to normalize policy in steady 25-bp increments. The Fed is likely to put a lid on terminal rates, while also signaling a long on-hold period, and many think the pricing of nearly seven rate cuts by end-2024 is excessive. Put another way, there is a good chance that we’ve seen the high for 30-year mortgage rates.

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