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Three Reasons Why Rates Might Have Peaked

February 22, 2022

Last Week in Review: Three Reasons Why Rates Might Have Peaked

Interest rates ticked up to their highest level in over two years but were able to finish the week off of the highest levels. Could rates have peaked? Let’s discuss why this may be so and look ahead to next week.

1.) Financial Conditions Have Already Tightened

Part of the Fed’s mandate is to maintain price stability (inflation). The Fed helps lower inflation by raising the Fed Funds Rate, which tightens monetary conditions and slows economic demand. If demand slows, prices come down.

Even though the next Fed Meeting is still one month away, and the Fed has not hiked rates since 2018, financial conditions have already tightened. The hawkish rhetoric and threats of multiple rate hikes have pushed up rates over the past 2 months to the highest levels in years. This has already had an impact on housing.

Of course, refinance mortgage activity is down sharply and that is to be expected with 30-yr rates up nearly 1% this year.

Now we are seeing an impact on new home sales. When you combine the lumber inflation, additional supply chain-related costs, and the recent uptick in rates, the National Association of Homebuilders reports that nearly 7 out of 10 borrowers can’t afford a new median-priced home. This is an unsustainable trend. Either rates must come down a little to provide relief or home prices must come down or a combination of both.

Last Summer, in front of Congress, Fed Chair Jerome Powell was heavily criticized for creating “froth” in the housing market by purchasing mortgage-backed securities every month. What we don’t know is how much “froth” the Fed wants to remove from the housing market. It’s hard to imagine the Fed tightening conditions and allowing mortgage rates to increase so much that housing sees a sharp slowdown.

2.) Things Are Not All That Peachy

In addition to the inflation problem, the economy is decelerating. Economic growth is slowing. The consumer is assuming more credit card debt to pay for items and fuel costs are soaring. This is a very difficult environment for the Fed to hike rates aggressively.

Moreover, consumer sentiment and small business sentiment are down sharply with the former at 11-year lows. In this environment with high inflation and low consumer sentiment, the Fed may try to be more patient with a hike rate and wait before approaching. Seeing the 10-yr Note yield decline beneath 2.00% suggests the bond market is not worried about runaway inflation but may be looking at the notion of slower economic times ahead.

3.) Russia/Ukraine Remains Unresolved

Uncertainty around Russia and Ukraine continues. When uncertain geopolitical events take center stage, the investment community adopts a risk-off trade and buys US-denominated assets like the US Dollar, Treasuries, and even MBS.

There is a fear Russia will indeed invade Ukraine and this will send the price of oil above $100 quickly. High oil prices are a killer. It’s a tax on consumers that goes uncollected. Should the Russia/Ukraine story escalate, and oil prices head higher, the Fed will have to soften its tone and be more dovish or accommodative. The opposite is true – if Russia/Ukraine comes to a political resolution, we could easily see rates pop back higher as the uncertainty is lifted. The longer this story lingers the less likely the Fed can be hawkish and hike rates.

Bottom line: The uncertainty and slowing in some sectors of our economy is giving interest rates some relief. This story could change quickly, and rates could easily creep back up and strike new multi-year highs. If you are considering a mortgage, now is a great time amidst the uncertainty and modest rate relief.

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