After last week's surprisingly strong Jobs Report, Fed Chair Jerome Powell spoke about the economy and direction of rates. Let's walk through what happened and what to watch in the week ahead.
"The strong Jobs Report shows you why we think this will be a process that takes a significant period of time." Fed Chair Powell 2/7/23.
The Federal Reserve has a dual mandate, which is to maintain price stability (inflation) and promote maximum employment. On the inflation front, it appears inflation has indeed peaked and is on the decline. The Fed Chair reiterated the "disinflationary process" has begun. This is a positive development for the economy, housing, and long-term rates.
On the labor market front of the Fed's mandate, the Fed in its desire to slow demand and thus inflation, wants to see some unemployment. The good news/bad news? Last week, the Bureau of Labor Statistics (BLS) reported the unemployment rate at 3.4%, the lowest in 53 years...that is good news. The bad news is it means the Fed will look to raise rates by .25% in March and another .25% in May, thereby lifting the Fed Funds Rate above 5.00%.
This renewed outlook for a higher Fed Funds Rate has elevated uncertainty and volatility in long-term rates, which move up and down based on economic conditions and inflation, both of which are easing and a reason why long-term rates are lower than short-term rates.
"Likely to see some softening in labor market conditions" - Powell
This is a reasonable assumption considering the number of planned layoffs announced this year, while we sit at multi-decade low unemployment, it seems like up is the only direction for unemployment.
Soft Landing Back in Play
Due to the current strength of the labor market, there is a growing chance the Fed can raise rates and lower inflation towards its 2.00% target without triggering a deep recession.
History has shown that recessions do not take place with unemployment at 4% or below without some sort of surprise shock to the economy.
Let's hope the Fed is not too successful in "creating" unemployment because if it quickly rises, the idea of a soft economic landing could go away quickly too.
As we mentioned, long-term rates have responded negatively to last week's strong jobs report, because good news is bad news for bonds and rates. The 10-yr Note touched 3.33% last Thursday and touched 3.70% just a few days later. However, rates remain beneath where the 10-yr yield opened 2023 at 3.85%.
"We are going to react to the data" – Powell
Here the Fed Chair reminds the markets that last Friday's Jobs report was strong, but backward looking and lagging while other economic indicators show signs of s slowdown. The Fed does not want to over hike rates into a slowing economy and be the reason for the recession. So, while the market is currently pricing in two more rate hikes and a rate cut in December, this story could quickly change once again.
Rates and inflation have peaked. Housing activity has jumped in the past weeks as a result. The incoming data will determine how much better rates can get in the next few weeks leading to the next Fed Meeting.
Next week's CPI is a very important number. If it meets or comes in lower than expectations, we could see home loan rates revisit the levels seen last week right before the Jobs Report last Friday. We will also see the latest readings on housing and the strength of the consumer, by way of Retail Sales. As fast as the story changed when the strong jobs data hit, things can change quickly upon these reports.
Mortgage-backed security (MBS) prices determine home loan rates. The chart below is a one-year view of the Fannie Mae 30-year 5.5% coupon, where currently closed loans are being packaged. As prices go higher, rates move lower and vice versa.
MBS prices backed away from the best levels of the year and are now in the middle of a wide trading range. It will likely take some bond friendly news for MBS to push above the recent highs and see the lowest rates of 2023.
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